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U.S. Air Fares Rise for 2 Months in a Row: What Lies Ahead?

Maharathi Basu

U.S. carriers, with Boeing 737 MAX jets in their fleet, continue to suffer due to multiple flight cancellations, and air fares in the country are on their way up. According to data released by the Bureau of Transportation Statistics, August ticket prices increased 1.7% on a month-on-month basis. This followed the 2.3% increase in air fares in July. The reversal in direction followed several months of subdued air fares due to factors like capacity overexpansion.

Boeing 737 MAX Jet Groundings Hurting Carriers

All U.S.-registered Boeing 737 MAX jets have been grounded since March this year after they were involved in two fatal air crashes in different parts of the world over a span of five months apparently due to software malfunctioning. While the first accident took place in Indonesia during October 2018, the second one was the Ethiopian Airlines’ crash on Mar 10.

The subsequent grounding of the 737 Max jets has been hurting three U.S. carriers -- Southwest Airlines LUV, American Airlines AAL and United Airlines UAL -- that have Boeing 737 MAX jets in their fleet. Per a report by U.K.-based flight data information firm OAG, Boeing 737 Max’s grounding is estimated to hurt global airline industry revenues by $4.1 billion in 2019, including $600 million for the aforementioned U.S. airlines. All three aforementioned stocks carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

American Airlines, with 24 Boeing 737 MAX jets in its fleet, expects the jets in its fleet to remain grounded through Dec 3, 2019. As a result, the carrier anticipates approximately 140 flights to be cancelled per day through Dec 3.

United Airlines having 14 Boeing 737 MAX jets in its fleet, expects the carries to remain grounded through Dec 19. Southwest Airlines, with 34 such jets in its fleet, has decided to remove them from its schedule until Jan 5, 2020. The recent clash between the Federal Aviation Administration (FAA) and European Union Aviation Safety Agency (EASA) regarding the re-certification of Boeing 737 MAX jets has added to the uncertainties regarding their availability in the busy holiday season ahead.

Capacity Reduction & Increased Costs Behind Fare Increase

The grounding of the 737 Max jets have naturally led to the trimming of capacity. For instance, United Airlines had initially projected 2019 capacity to increase in the 4-6% band. In April, the guidance was revised in the 4-5% range. In July, capacity increase for 2019 was further reduced to the 3-4% range.

Also, Southwest Airlines expects 2019 capacity to decrease 1-2% year over year compared with the 5% increase expected earlier. Moreover, due to the MAX groundings, non-fuel unit costs are rising due to lower capacity. Southwest Airlines expects 2019 non-fuel unit costs to expand in the band of 8-10% year over year compared with a rise of 5.5-6.5% estimated previously. The forecast includes an approximate six-point negative impact from lower capacity due to the groundings.

Even carriers that do not have Boeing 737 Max jets in their fleet are practicing capacity discipline. This can be made out from the increase in load factor (% of seats filled by passengers) due to capacity growth lagging traffic increase. For instance, load factor at Delta Air Lines DAL improved 80 basis points to 86.7% in the first eight months of 2019. Similarly, the metric improved 30 basis points to 84.4% in the first eight months of the year at Alaska Air Group ALK.

What Awaits?

According to United Airlines’ recent commentary, “there’s room to raise fares” next year when Boeing 737 Max jets resume operations. This implies that air travel is likely to get more expensive going forward.

Moreover, with demand for air travel expected to remain strong, capacity decrease in the face of upbeat demand may cause fares to rise due to supply growth lagging demand. International Air Transport Association's forecast for 2019 further highlights the upward pressure on air fares in the United States due to excess demand. The association predicts capacity expansion of 4.1% in North America, which lags the 4.3% projected growth in passenger demand.

Increased non-fuel costs also put an upward pressure on fares as airlines attempt to balance out the increased costs by raising fares and thus maintaining their profit levels. Whatever the outcome, we anticipate investor focus to now remain on this burning issue of air ticket prices.

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