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U.S. Airlines: Global Competitiveness and Industry Viability John P. Heimlich VP and Chief Economist.

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Presentation on theme: "U.S. Airlines: Global Competitiveness and Industry Viability John P. Heimlich VP and Chief Economist."— Presentation transcript:

1 U.S. Airlines: Global Competitiveness and Industry Viability John P. Heimlich VP and Chief Economist

2 OVERVIEW 2 DOT mission explicitly recognizes importance of airline viability/competitiveness A viable, competitive U.S. airline industry is good for the country, fueling jobs and growth Numerous stakeholders benefit from a financially viable, competitive U.S. airline industry From a customer standpoint, the U.S. airline industry is unquestionably competitive The U.S. airline industry is financially weaker than other U.S. industries U.S. airlines are financially weaker than most non-U.S. airlines The domestic market has matured; the battlefield has shifted to the global stage To reinvest in product/people, U.S. airlines need substantially improved finances Competing effectively in global market is essential to airlines and good for the USA

3 DOT Statutory Mission Explicitly Recognizes Importance of (and Role in) Industry Viability and Competitiveness U.S. Code, Title 49, Sec Policy, Subsection A: “Economic Regulation” (6) placing maximum reliance on competitive market forces and on actual and potential competition — (A) to provide the needed air transportation system; and (B) to encourage efficient and well-managed air carriers to earn adequate profits and attract capital, considering any material differences between interstate air transportation and foreign air transportation. (14) promoting, encouraging, and developing civil aeronautics and a viable, privately- owned United States air transport industry. (15) strengthening the competitive position of air carriers to at least ensure equality with foreign air carriers, including the attainment of the opportunity for air carriers to maintain and increase their profitability in foreign air transportation. (16) ensuring that consumers in all regions of the United States, including those in small communities and rural and remote areas, have access to affordable, regularly scheduled air service. 3

4 A Viable, Competitive U.S. Airline Industry Is Good for The Country, Fueling Jobs and Economic Growth 4 “Aviation is the glue that keeps the global economy together. Without widely accessible and well-priced air travel, the global economy will quickly become less global.” — Dr. Mark Zandi, Chief Economist & Co-Founder, Moody’s Economy.com (August 2008)  $1.225 trillion/year in economic activity  $371 billion/year in personal earnings  10.9 million jobs “The Economic Impact of Civil Aviation on the U.S. Economy” (FAA, Dec. 2009) Commercial aviation helps drive: Commercial aviation contributes:  $731.5 billion/year to U.S. GDP  5.2% of U.S. GDP “Economic growth and prosperity are determined in large part by access to the global economy. And, just as islands require bridges to the mainland….communities require bridges to the global economy. Air transportation is that bridge, providing the necessary access for U.S. cities…to enjoy a ‘Virtuous Circle of Economic Growth.’” “The Plane Truth About Air Service and Economic Development,” Global Aviation Improvement Network, Booz Allen (March 2001) “Every day, the airline industry propels the economic takeoff of our nation. It is the great enabler, knitting together all corners of the country, facilitating the movement of people and goods that is the backbone of economic growth. It also firmly embeds us in that awesome process of globalization that is defining the 21st century.” — Daniel Yergin, Author, Commanding Heights: The Battle for the World Economy, in the ATA 2005 Economic Report

5 Commercial Aviation Drives Nearly 11 Million U.S. Jobs 5 U.S. Job Impact by Aviation Activity, In Millions Source: Federal Aviation Administration, “The Economic Impact of Civil Aviation on the U.S. Economy,” (December 2009)

6 Numerous and Varied Stakeholders Benefit From a Financially Viable, Competitive U.S. Airline Industry Continuity of Plentiful Service, Job Security, Reinvestment in Product and People Continuity of Plentiful Service, Job Security, Reinvestment in Product and People Airline/Airport/Aerospace Workers Hub Cities Spoke Communities U.S. Treasury Small Businesses Corporate America Aviation Suppliers National Defense Air Travelers and Shippers People Who’ve Never Flown Agriculture Interests Manufacturing Sector Importers/Exporters Travel and Tourism Humanitarian/Relief Workers Medical/Emergency Personnel 6

7 From a Customer Standpoint, Former DOT Officials Recognize the U.S. Airline Industry As Unquestionably Competitive 7 “The purpose of this study is to examine the competitiveness of the U.S. domestic airline industry following a period of unprecedented financial turmoil and considerable change in industry structure…. [T]he industry is more competitive now than at any other time in the 12-year period examined.” “One area of promise for the network airlines is the prospect for continued international expansion to provide support for their domestic networks. Although the airlines (and consumers) have benefited from the international network development enabled by the liberalization created by open skies agreements, the potential for much greater progress is large.” — Former DOT officials Randy Bennett, Patrick Murphy and Jack Schmidt, “A Competitive Analysis of An Industry in Transition” (July 2007)

8 Airline Industry ROIC Worst Among U.S. Industries Historical Average ROIC (Percent) in U.S. Sectors, SOURCE: Corporate performance database Energy Materials Capital Goods Commercial Services and Supplies Transportation Automobiles and Components Consumer Durables and Apparel Consumer Services Media Retailing Food and Staples Retailing Food Beverage and Tobacco Household and Personal Products Health Care Equipment and Services Pharmaceuticals and Biotechnology Technology Hardware and Equipment Semiconductors and Semiconductor Equipment Telecommunication Services Utilities Airlines ( ) th Percentile 75 th Percentile Median Range of typical WACCs

9 Healthy Investment Requires Healthy Equity Equity Market Capitalization (Billions) as of August 2 * AAI, ALGT, ALK, AMR, CAL, DAL, HA, JBLU, LCC, LUV, MESA, PNCL, RJET, SKYW, UAUA, XJT 9

10 Competing Globally Will Require Strength at Home Constraining U.S. Carriers Domestically Will Have Lasting Implications Source: ATA and Morgan Stanley Net Profit Margins: Calendar Years

11 S&P Corporate Credit Ratings (July 12, 2010) for North American Transportation Companies, “Strongest to Weakest” 1.Union Tank Car 2.UPS 3.TTX 4.AMTRAK 5.Canadian National Railway 6.Kirby Corp. 7.Burlington Northern 8.Enterprise Holdings 9.Norfolk Southern 10.Ryder System 11.Alexander & Baldwin 12.GATX 13.Union Pacific 14.FedEx 15.Hunt (J.B.) Transport 16.Brink's Co. 17.Aviation Capital Group 18.Canadian Pacific Railway 19.Southwest Airlines 20.CSX 21.Con-way 22.ILFC 23.AWAS Aviation Capital 24.Teekay Corp. 25.AMERCO 26.Kansas City Southern 27.Mobile Mini Inc. 28.Overseas Shipholding Group 29.Kenan Advantage Group 30.RailAmerica 31.Avis Budget Group 32.US Xpress Enterprises 33.Hertz Global Holdings 34.Alaska Air Group 35.Global Aviation Holdings 36.Marquette Transportation 37.United Maritime Group 38.Delta Air Lines 39.Ozburn-Hessey Holding Co. 40.American Commercial Lines 41.Horizon Lines 42.General Maritime Corp. 43.Continental Airlines 44.Dollar Thrifty Automotive 45.UAL Corp. 46.Coach America Holdings 47.JetBlue Airways 48.AirTran Holdings 49.JHCI Acquisition Inc. 50.Quality Distribution Inc. 51.Trailer Bridge Inc. 52.Western Express Inc. 53.AMR Corp. 54.US Airways Group 55.Air Canada 56.Swift Corp. 57.Evergreen International 58.YRC Worldwide AA- to A-BBB+ to BBB-BB to BB- to CCC- 11

12 U.S. Airlines – “Low Cost” or Otherwise – Cannot Justify Growth or Reinvestment Without Substantial Gains in ROIC “…LUV...reiterated that it does not intend to grow its fleet significantly until its financial goals, including a 15% ROIC are in sight. On a rolling 12 month basis, LUV’s current ROIC is about 7%, including two tough quarters in 2H09... We do not believe LUV will seriously look at growing its fleet significantly until 2012 barring a double dip recession, jet fuel price spike or other ‘black swan’ events that often befall this industry.” — Research Update (July 30, 2010), Michael Derchin and Ben Shim, CRT Capital Group LLC 12 “We do not intend to significantly grow the fleet until our financial goals are achieved or in sight.” — Southwest Airlines CFO Laura Wright, July 29, 2010 earnings release, citing the company’s goal of achieving a 15% pretax return on invested capital

13 The Future Lies Across the Pond(s) Thinking Outside the [Domestic] Box Airbus Global Market Forecast Annual Traffic Growth: Boeing Current Market Outlook Annual Traffic Growth:

14 14 Airline Energy Costs Are High and Poised to Rise

15 What’s Wrong With This Picture? The Investor’s View “The poor financial performance of the industry through full business cycles can be attributed to its high fixed cost structure, overleveraged balance sheets, low barriers to entry, high barriers to exit, fragmentation, and fierce competition from low-cost domestic carriers and recently-consolidated, well-funded international carriers in Europe, the Middle East, Asia and Latin America… As you weigh policy objectives for the airlines, you may want to consider the benefits from having airlines in a better position to generate a return on invested capital in excess of their cost of capital through a full business cycle. The balance between positions which seek to socialize aspects of the airline industry versus those that promote growth in the free market will contribute to how the market prices airline capital risk and measures the required rate of return to justify growth. The ability to generate more consistent returns on equity and increase free cash flow is the path to repairing balance sheets and longer term financial stability. Only then will there be a solid foundation for increased capital expenditures, rising wages, and increased service.” — Statement of David R. Strine before the House Transportation and Infrastructure Committee Subcommittee on Aviation, “Consolidation In The Aviation Industry, With A Focus On The Proposed Merger Between United Airlines And Continental Airlines – A Perspective From Within The Financial Markets” (June 16, 2010) 15

16 Where Do We Go From Here? 16  To invest in people and product, airlines require sustained profitability – they must earn their cost of capital over the entire business cycle  U.S. airlines are climbing out of a deep hole – doing better financially should not be equated with doing well (or well enough) financially  By just about any measure, U.S. airlines are less equipped than other airlines and other industries to compete effectively on the global stage  Barriers to exit, higher taxes, environmental charges, inefficient infrastructure (air traffic control vs. air traffic management) will exacerbate inadequate financial condition and the competitiveness gap  Consistent with DOT mission, promoting and encouraging the development of a viable, competitive U.S. airline industry is in our national interest

17 DOT Statutory Mission Explicitly Recognizes Importance of Industry Viability and Competitiveness U.S. Code, Title 49, Sec Policy, Subsection A: “Economic Regulation” (6) placing maximum reliance on competitive market forces and on actual and potential competition — (A) to provide the needed air transportation system; and (B) to encourage efficient and well-managed air carriers to earn adequate profits and attract capital, considering any material differences between interstate air transportation and foreign air transportation. (14) promoting, encouraging, and developing civil aeronautics and a viable, privately- owned United States air transport industry. (15) strengthening the competitive position of air carriers to at least ensure equality with foreign air carriers, including the attainment of the opportunity for air carriers to maintain and increase their profitability in foreign air transportation. (16) ensuring that consumers in all regions of the United States, including those in small communities and rural and remote areas, have access to affordable, regularly scheduled air service. 17

18 When America Flies, It Works


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