Southwest's New Cities and Rambling Thoughts on Earnings

Last week, my post analyzed Southwest's evolving network design which helps support many of the new cities. While I prognosticated more cities would likely come online, I did not expect COS, JAN, nor SAV. Nor did I expect new cities so soon. Rather, I expected new summer seasonal only cities, not new structural cities. 

For these new cities, Southwest announced they would join the network in the "first half 2021". If I were a betting man, I would expect these cities' schedules to be released for operation in March but most likely in April. While March is currently published, the schedule is absolute rubbish. Currently, the schedules published in January and beyond show a full block hour recovery. Note, I am using block hours as I believe it to be a better measurement of aircraft utilization.

We know this schedule is simply not going to fly. Between the VSP and potential furloughs, there is no way Southwest can operate a 2019 nor 2020 flight level in the first quarter. Additionally, demand nor revenue have recovered to levels that would support the amount of capacity either. Yes, TSA passenger screening rates are looking better recently, but we still have heard little conversation regarding forward-looking fourth-quarter revenues. 

During the earnings call, Tom Nealon talked about how Southwest was revising schedules: 

"We continue to adjust our flight schedules in 30, 60, 90-day increments. At this point, we are in a very, very clean rhythm to do so effectively and efficiently. We are getting pretty good at this."

This flashes the chainsaws are about to come out for January and beyond. It is difficult to know exactly how these changes to be executed, but options range from significant overhauls to a clean sheet republish. Either option would allow for the new cities, including ORD and IAH, to be slide into the schedule.

If March is not your bet for COS, JAN, and SAV, you would have in good company to suspect April as well. According to the Southwest website, the schedule for April 12 thru June 5 is expected to publish on December 20. Additionally, Gary's comments state there will be a second-quarter launch for some of the new cities. 

"Number three, we have announced nine new destinations to be added over the next three quarters. I'm happy to have these opportunities. I'm happy to play offense." 

With MIA, PSP, HDN, and MJT launching in 4Q2020, and it could be assumed IAH and ORD launch sometime in the first quarter, it is easy to suspect COS, JAN, and SAV start in 2Q2021, which would round out the last of the three quarters in Gary's statement. 

So, what should we expect COS, JAN, and SAV to look like? At a high level, I would expect the cities to be around a PSP flight level. I am not, however, going into the sausage-making of which markets which I would recommend. The airports have great consultants or professional staff working the analysis. I don't need to be giving free consulting services. And, let's be honest, SWA has already determined the initial capacity sets anyway. 

To me, one of the biggest wildcards for each of these small cities will be how competitors react. The legacies should continue their standard legacy service. I would not expect any competitive reactions in the COVID world, nor would I expect them to drop service. With no LCC/ULCC service, JAN should see above-average growth compared to its peers. 

SAV, on the other hand, is an Allegiant destination city. This typically means crews and aircraft are based there for the operation. With this investment level, Allegiant has to maintain a minimal level of service at the city overall to keep crews and aircraft productive. While we could see SWA overlap in a few cities, Allegiant has competed with SWA in the past and could reasonably be expected to brush off any direct competition. 

Then we have my old airport, COS. Hopefully, with the SWA announcement, the locals can now quit talking about the glory days of WestPac. However, I do have concerns with competitive responses in COS. The only ULCC operating in the market is Frontier, and I wonder if there is a potential that F9 might pack up and leave. 

I have been able to determine one Frontier has a single strategy to date: make money. If a route or city is not at the profitability Frontier wants, expect them to leave. Depending on both WN and F9's routes into the city, we could see a significant overlap. This could cause Frontier to take their ball and go home. The carrier is not known to be loyal to any city or route. I don't mean this from a negative perspective. The airline's job is to produce returns for its investors, and competitive overlaps into smaller cities may not allow this. 

On the flip side, Frontier has had an extensive product offering in COS since its relaunch in 2016. During June 2018, COS was Frontier's 12th largest city. However, Frontier has dialed their investments in the city back, even pre-COVID. Currently, the only two routes operating in the COVID schedule are LAS and PHX, two of Southwest's largest stations. If Frontier were to leave, this would mute the city's positive passenger growth. 

Let's come back to Southwest's other new cities, IAH and ORD. While the city schedules are not yet published, that didn't prevent SWA leaders from discussing them on the earnings call. The discussion around IAH was pretty bland, so I continue to believe we could see MIA level of service around 12 flights, maybe a notch higher. This would be large enough to continue to spread underutilized ground ops employees out. 

"We're going to have a great schedule out of there. Houston, the City of Houston and the airport system are very supportive of Southwest, and they're a delight to work with. So, we’ve got the real estate access. I would contrast that -- so again, it’s a great opportunity. If it’s a leisure oriented world for a while, there’ll be plenty of leisure customers that we'll be able to take to and from and through Houston Intercontinental." - Gary Kelly 

Gary's comments on the earnings call clarify O'Hare was an opportunistic COVID move.

"O'Hare is different in the sense that we're going to continue to grow back to the Houston example out of Houston Hobby. We'll continue to invest and grow, not right now because of the pandemic, but this will pass. Chicago is very different. We are not able to continue to grow, once the pandemic has passed at Midway. And I'm sure you're familiar with the constraints there. So, I just can't fathom that it's a good strategy for our Company to sit here and say for the next generation we cannot grow in Chicago. So you can kind of go through the mental list of what the options are.

And I can assure you that trying to expand Midway is not an option. It is just literally not a feasible option. Certainly, it's nothing that could happen in a short period of time, and it would cost a bloody fortune. So that leaves O'Hare. And O'Hare was real estate restricted, and now it's not. And so, we're there. And I'm very much looking forward to that opportunity. Like Houston, it will also offer access to a section of the metro area that we probably don't serve very well in the north. But I think we'll likely have a similar route system to begin to plug into our strengths, and I think we'll do very well there and it will complement Midway very well.

And then, finally, I guess, yes, they're not leisure destinations per se, but there are plenty of consumers that we're getting on our airplanes all over our system. And again, I think pretty much explains why the timing is what it is with O'Hare. If we don't move now, we risk never getting in there. So, we're moving now."

There are a few things that I take from the above quote. First, Gary says, "we'll likely have a similar route system to begin to plug into our strengths." This gives us a general tip where we might see SWA go. Predictably, we could see the same banked cities that we have seen other new cities plugged into. 

But given the amount of time spent on O'Hare, the conversation regarding limitations at MDW, and the limited real estate in ORD, something feels different here. It is entirely possible that we see an MIA flight level approach, and I am just reading too much here. But, if you are completely constrained in your main airport and may not have the opportunity to grow in your new secondary, you might try to shoot high and regret later. Worst case scenario, you reduce flights and return underutilized space and gates.  

Finally, I think the question still needs to be asked, is there more coming? Ultimately, I still see the case to onboard a few more cities. The likelihood of new structure cities such as SAV, COS, and JAN is less likely for right now. There's always a balancing act of accessing new revenue vs. a decaying rate of return. I believe it is more likely we see the introduction of summer seasonal cities similar to the winter seasonal cities of MJT and HDN. 

"At this point, with COVID, we're actually in an aircraft surplus position, and now we're able to put idle aircraft and our people to work, while at the same time strengthening existing markets in our network that are already very, very strong, markets like South Florida, California, Denver, Chicago and Houston. These are markets where we have a significant presence, and these are cornerstones of our network, and these additions only make them stronger still." - Tom Nealon

I could easily be convinced that Southwest will continue to find itself in an aircraft surplus position even with all new announcements. If the upcoming schedules show no more than 60% of 2019's block hour, I would argue there could be an opportunity to deploy additional aircraft if the revenue environment is there. That seems to be a big if. However, more new cities, especially seasonal summer cities, could play a part in generating much-needed cash for the network. 

I would be remiss if I didn't at least touch on furloughs. Potential furloughs could limit the carrier's growth as well. If an additional 10%+ of employees are furloughed to reduce cost, 2021's deployable block hours will be reduced. As of right now, I think the unions are playing hardball, hoping that either the company backs down or additional federal aid comes thru. At this point, I don't see either happening. If furloughs are executed, expect SWA to accelerate aircraft retirements to get maintenance, insurance, and ownership costs down. We could then see an even more prolonged recovery for the carrier. 

On a more positive note, right now is an interesting time to be a network planner. Multiple years of master plans have been thrown out the window. Today, planners are trying to find what little money is on the table. This allows guard rails of the past to be broken. But don't think SWA is the only carrier with unpredictability up their sleeve right now. In the coming weeks, we will likely see other carriers start playing their cards as well. It is not long before peak-March demand (albeit at a lower demand level than normal) will start hitting the 90-120 day window where many carriers are planning their capacity.  

Keep an eye on the hybrid and ULCC carriers. Specifically, I would not be surprised to see JetBlue or Spirit start announcing larger network adjustments as soon as this week. Remember, it is earnings week for these two. 

Nothing takes the wind out of bad earnings like a new shiny object.  

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Note: All quotes from the earnings call came from Seeking Alpha.

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What's Southwest's Network Strategy?

 Note: Over the last year, I have intentionally stayed away from much direct analysis of Southwest Airlines. As discussed in my ethics pages, I am a former SWA network planner and was aware of the network strategies and tactics. However, after being away from the organization for two years and COVID-19 tossing all the network planning rules out the door, I'm confident to say I no longer have inside information, and I'm comfortable analyzing SWA's newest network changes. The discussion below is entirely based on publicly available data and my best thoughts on what is going on at the airline.   

COVID-19 has turned every airlines' revenue management, marketing, and network planning strategies completely on their heads. Gone are the good ole' days where ticketing revenue was predictable down to the day and hour with +/- .1% error. Legacy carriers have completely shifted away from their traditional 330 days of rolling inventory and are now making monthly adjustments to their entire network structure. 

ULCC carriers, which generally skew towards leisure demand, saw quicker recovery rates over the summer, just to see them tail off in the latter part of August into September. While 3Q TSA screening rates have "recovered" to 28% of the prior year, Delta and United have reported that ticket revenue was only 17% and 16%, respectively, of last year. While other revenue streams were "better," overall revenue was down roughly 80% for both carriers. While I suspect LCC/ULCC carriers to post slightly better results, better is a relative term. All airlines are hemorrhaging cash, and it's not just a flesh wound. 

The massive amounts of debt airlines are currently incurring to stay alive will limit their ability to grow by any significant measure for the foreseeable future. This can be seen by Boeing's latest forecast, where they do not expect the historic 4% growth rate to recover for at least five years. 

While I plan a deeper debt to growth analysis in the future, we can say with some certainty for each multiple of billions of debt an airline issues to survive, we will see a corresponding increase of deferred future growth. As the CARES Act expired, buyouts and layoffs at carriers kicked into high gear. Even Southwest is now issuing warnings to employees of the need for salary reductions or furloughs to reduce cash burn. None of these actions should be considered typical management vs. labor disputes/bluffs of the past. If carriers continue to issue debt to survive, we should expect to see five-plus years of limited growth, hub closures, and aging fleet.

While airlines try to reduce cash burn, they are also becoming increasingly nimble with their network. Both American and Delta have cut smaller cities following the CARES expiration to reduce costs and eliminate controllable cash burn. Southwest, however, is taking a different tack. Southwest has announced six new cities to tap into new revenue streams. For those not following airlines day-to-day, these new cities are Palm Springs, Houston (IAH), Chicago (ORD), Miami, Montrose (seasonal), and Steamboat Springs (seasonal). And while this set of new cities seems quite diverse, my goal today is to show you they all seem to follow the same approach. 

Before we get to the current network state, we need to look at Southwest before COVID. While we all like to rib Southwest for selling TPA-STL-DAL-PHX-LAX flights, a majority of the Southwest passengers fly on single coupon tickets. In other words, most of Southwest passengers fly nonstop or direct. Granted, over the years, this has been somewhat in decline. 

Southwest's network is incredibly complex and simple at the same time. While Southwest often states it doesn't have hubs, it does have ICOs or intentional connecting opportunities. Generally, ICOs are designed as small connecting banks, often 10 or fewer flights, strategically placed around the network, often within the largest Southwest cities. While the ICOs allow structured connections for passengers to flow across the system, the Southwest network generally focuses on nonstop demand. However, in the COVID environment, Southwest's connecting network design appears to have been placed on steroids.

There are quite a few changes in the Southwest network that took me by surprise. First, schedule volatility has increased significantly. In 2019, schedules were usually only adjusted on Saturday and holidays. In 2020, it seems that each day has its own schedule. 

Let's take a deeper dive into an individual day. For my analysis below, I am using the December 7, 2020 schedule and comparing it to the week's same day last year (December 9, 2019). Really any day could show a similar trend; however, I decided to pick a day that appears to be a stable and repeated schedule for at least a couple of weeks. At a high level, we see SWA is much slower to ramp up the network and terminating at a much earlier time than 2019. This should be expected as demand for early morning flights and late-night flights is generally much lower than the day's core. 

Nothing surprising so far, but let's take a look at individual cities. When we review the largest SWA cities, we see that the network is under a complete transformation, enabling many of the new cities to come online. Let's take a look at MDW. In 2019, we can see hourly departures averaged between 10-15 departures with some peaks. Those peaks were the ICOs we previously discussed. ICOs are elevated times of departures but not typically heavily concentrated like we would see with American in CLT. However, when we look at 2020, we see the ICOs were removed for three consolidated peaks. In between the peaks, the Chicago operation is relatively idle. 

ATL's flight structure has more extreme banks than MDW. In 2019, ATL averaged around five departures an hour with small departing ICOs in the morning and evening. In 2020, if the flights are not directly connected from ATL's two large banks or a more shallow 3 pm bank, flights really don't operate. When we look at the flights operating outside of the banks, most of the flights depart for another banked mega city.

This structure is not limited to ATL and MDW. I found consolidated banks in ATL, BNA, BWI, DAL, DEN, HOU, LAS, MDW, OAK, PHX, and STL. I could even be convinced there is a mini-bank in SJC as well. But what does this all mean?  Well, let's take my home airport, OKC, as an example. Oklahoma City only connects into cities with banks, and most flights are feeding banks. 

When comparing the network year-over-year, 88% of Southwest flights are now connected to cities with banks. This is up year-over-year by 11pts. What is left within the Southwest network that is considered point-to-point? Calfornia, Hawaii, and Florida. Outside that, if the route is not connecting into one of Southwest's largest cities, it was eliminated. 

Let's take a look at another legacy small Southwest city, Tucson. In total, Tucson has had their flights reduced from 13 daily flights to five. When we take a look at the cities removed, non-banked cities were removed entirely. Chicago, a long haul flight, was also removed in place of Houston, which hits the banks as well. 

So, what's all this have to do with the new cities? Well, everything. Let's take a look at Palm Springs and Miami, which launch November 19th. PSP connects right into the banked cities. Out of the five flights operating into PSP on December 7th, four of them are directly connected to banks feeding the city. 

 

Miami follows a nearly identical approach to the design. For most cities, MIA is near or in most banks, excluding flights to TPA. Honestly, I can't figure exactly what SWA's thinking is with flights to TPA from MIA unless they are expecting organic connectivity on TPA's Midwest flights. 

As the new city list expands to Montrose and Steamboat Springs, the strategy largely stays the same with flights connecting into Denver's banks. I suspect O'Hare and Houston Intercontinental could take a similar approach.

With the extreme banking and new cities, does this mean there is a change on the horizon? I don't know about the long term, but I believe that we could continue to see Southwest expand their city list in the near term with the push to diversify revenue. 

If I'm reading the ground ops union contract correctly, Southwest only has to notify the union of their intent to outsource. There is no explicit requirement for Southwest to insource ground ops until a city operates more than 12 daily flights. No city, excluding Miami, is even close to this. This allows Southwest to spread their fixed costs and access new revenue streams without new employee costs. If Southwest employees handle larger cities such as Miami, O'Hare, or Houston Intercontinental, the company could allow bids from underutilized employees throughout the system. Again, this would come without much incremental cost to the company. 

This should raise questions for air service development professionals. If the negative impacts of COVID continue and airlines desperately look to diversify their revenue stream, could we see Southwest operate more new, small cities? Absolutely. With the Southwest network banked and seemingly relying on connections, it seems probable that we will see more cities announced by Southwest, not city closures that we have seen from other carriers.  

On the flip side, if you are an existing Southwest city that is already connected to the nearest banked cities, it is unlikely that you will see much growth unless you have demand for a point-to-point leisure location such as Florida or Hawaii. 

With earnings coming up on Thursday, we should hear some conversation around Southwest's future network strategy. It would not shock me in the slightest to hear additional future network plans, including routes for ORD and IAH, or if more cities may be added to the network. If we hear significant updates from Southwest's comments, I plan on updating this article. 

California Love? NK's SNA Announcement

Over the last few weeks, airline networks have become increasingly dynamic. As expected, airlines have continued to hack away at their future fall and winter schedules. At the same time, planners are returning previously operated routes back to their network and experimenting with new routes (American new routes, United to Florida, Delta MEM-IND). 

While a lot is going on, Spirit's new Orange County service really caught my eye. Why? There's a lot of history tied up in these three flights. Yesterday, Spirit announced they are placing Orange County (SNA) on their network with service to Oakland (2x) and Las Vegas (1x) starting November 17th. 

Since the Wright Brothers flew at Kitty Hawk, airlines have been fighting over the LA Basin. In the early 1990s, Southwest grew quite extensively in Intra-California as the original PSA was cut down after US Air acquired them. Fight after fight, Southwest ended up the king of the Intra-California market by way of their secondary market, Intra-California strategy. 

Southern California has always been one of those complex markets. The main airport, LAX, is insanely expensive and with continued (and often unnecessary) capital investment, cost per enplaned passenger has become outright insane with the Fitch credit rating stated cost per enplanement is expected to reach $30 per enplaned passenger. Even at $30 per enplanement, the airport still hasn't fixed their access/egress problems at the airport. 

It also should be pointed out the $30 per enplanement projection was prior to COVID suppressed enplanements and after Fitch raised their pre-COVID cost per enplanement forecast by $5 per enplanement from their forecast only one year earlier. I would expect LAX's unit costs to skyrocket further in today's environment. Remember, these costs are fees paid by the airline to the airport and do not include any of the airline's operational costs associated with their employees. 

In past economic downturns, airlines typically consolidated around LAX and abandoned the secondary Basin airports. This would typically make sense as alliances and more extensive operations allowed for enhanced connectivity. However, overall Basin Airport seat share for LAX topped out in 2016 and has been in a steady state of decline as carriers have started to fight over the secondary markets. 

Each of the secondary markets is unique. BUR, LGB, and SNA are all artificially constrained by noise caps. Burbank by gates, SNA by seat allocations, and LGB by slots. Ontario is the only secondary airport that is not limited to noise operations in any way. As airlines shifted away from LAX starting in 2016, two fights developed in the secondary airports: access to constrained airports and Alaska growing their California operation. 

Orange County, in particular, is an interesting airport. The airport, controlled by strict enplanement regulations, was left in the dust by most carriers during the last recession. Only Southwest continued to grow in the market until 2016 when their seat allocations were cut as other carriers requested access into the city. 

While Orange County has largely stayed flat in seats due to their seat allocations, the other constrained, secondary LA Basin airports started to see growth in beginning in 2016 as well. This was in part due to airlines shifting more capacity into the cities, as well as competitive pressures from Alaska. Long Beach, which peaked in their capacity in 2017, declined due to JetBlue's attempts to make the market work. ONT really deserves its own future post as it has transformed itself in a post-LAWA world. 

When we take a more in-depth look into secondary airport growth, we can see two trends Southwest cut a massive amount of their seats following the last recession and the 2015 forward growth came from Delta and Alaska as well as Southwest adding back the seats they previously cut. This really should not be a surprise if you've paid attention to the industry over the last couple of years. Both Southwest and Alaska competed heavily to be California's intra-state carrier. 

If you've made it this far, you're like asking yourself, "So, what does all this after to do with Spirt's new routes from SNA?" Well, one of the most essential things to route development is understanding who is actually making the route decisions. Some of the network planners at Spirit encompass both old AirTran/Southwest and Alaska folks. These network planners know how well Southwest performed within Intra-California. 

When we look at publically available DOT data, in 2016, before Intra-California was flooded with capacity, most Southwest's routes performed at or above system RASM curves. This helps explain why Alaska saw an opportunity to skim off the top in California. They knew Southwest overperformed in California and Virgin America had a large and loyal customer base. 

Even after all the capacity from Delta, Alaska, and Southwest, what route appears to perform better than all other Intra-California routes? You've guessed it, SNA-OAK. Spirit is hoping to skim off the top with their two new flights and expect to find California gold on the route. Do I think it will work? I give it a big maybe, but they have the best chance out of all carriers. 

When we take a look at the overall market share of Oakland, Southwest has a commanding lead of 73% of all passengers, with splitting the #2 and #3 Spirit and Alaska operating around 6-7% market share (Airlinedata.com). This is before American quit the market at the start of the virus. 

Now, I do want to be clear, I do not think the Spirit planners are targeting SWA more than any other carrier. All of the ULCC planners pull competitor's RASM curves and look for high passenger volume, over-index RASM performing markets. These high-performing, competitive markets are often ripe for passenger and fare stimulation. 

But, what is interesting to me is OAK-SNA will be Spirit's first secondary-to-secondary market route in California. Spirit skipped over other, larger Intra-Cal passenger and revenue markets to go after SNA to the Bay. SNA to the Bay produced a $20 premium compared to other Bay to Basin markets in 2019 (Source: The Hub by Airline Data Inc www.airlinedata.com).  

Unfortunately, we will never know how well the OAK-SNA market works for Spirit. The ULCC model relies heavily on "fees" (i.e., excise tax avoidance strategies), which are not reported on route level performance for their ancillary products. It is not possible to correctly prorate "passenger usage" fees, bag fees, etc., down to the leg level unless the DOT changes their reporting requirements. Don't hold your breath.  

I do think Spirit has a reasonable shot at making SNA-LAS work. From all of their California stations, Spirit operates at least one daily flight and often multiple daily flights to LAS. This appears to be beyond just an easy routing out of a crew base to make flight rotate easily. They are likely making some money here. Vegas is a bottomless pit of demand if you drop your fare low enough.... which Spirit is happy to do. 

Exactly what Spirit has in store for Oakland long term is difficult to know. Currently, October and November schedules show Spirit operating LAS and LAX multiple times daily, with less than daily service to Chicago and Houston. Currently, Houston and Chicago are scheduled to be discontinued in December, which I assume Orange County will take the place of. This would make the station balance around five daily departures, which Spirit promoted in their press release. 

Five flights do not feel like a long term solution for Spirit in Oakland, but we will have to wait and see. It would not surprise me to see Spirit turn more flights south out of Oakland once the economy starts to recover. 

Time to Close Some Cities

As we approach the ending of the first CARES Act funding, it is time to stiffen up our upper lip and realize it is time that airlines start closing cities. Last week, CNBC reported that American was looking at losing up to 30 small cities. Immediately afterward the article was published, I saw armchair quarterbacks from all areas of the social sphere immediately point to the convince of the timing of the leak. Yes, unions have taken an active lead with management support in advocating for another round of CARES funding. 

But let's cut the crap. Airlines are already stating they will be smaller coming out of the crisis than they were when the crisis began. How can airlines significantly reduce their network without cutting underperforming cities? Hint: they can't. As tough as it is to hear, it has to be said. 

But let's not kid ourselves either. Airlines have always made small cities the scapegoat for difficult capacity cuts. Why? First, larger cities are much more likely air service development teams that have built strong bonds with network planners. All things being equal, it is much easier to cut a city or route from an airport that you have no relationship with. Yes, you or your airport affairs peer will likely get screamed at by a director at a small airport for a few minutes, but then it is over. If you have a professional relationship with a team, it is much harder to make those calls. 

Second, scheduling into smaller cities is much more difficult. A planner can throw a single flight into Denver or Chicago and make something work. Small cities, however, you are much more limited in potential route and scheduling options. As a network carrier, you can fly a few frequencies into the nearest hub, but small cities will need to hit the inbound and outbound banks to perform. This means you might have an aircraft sitting in a small city for hours when it could be out flying. 

During the last recession, small airports really took it in the teeth with capacity. The smallest 25 percentile airports had their capacity reduced at a much larger proportion and much quicker than any other airport. Additionally, these airports were also last to see their capacity return. 

Not only were smaller airports more likely to lose their service, but 58 of the smallest 159 airports (bottom 25%) also lost all of their air service since the last recession. This is why you will see small airports become much more vocal and divisive, at least locally, about their air service offering. For these airports, it often is an airport versus the airline world. 

If you have read my blog long enough, you know very well I have not been 100% accurate on all my predictions. In July, I stated I expected travel demand to drop off significantly in the second week of August. I will happily eat crow served from this incorrect prediction (but still very cautious about September). Nominally, TSA passenger traffic has actually increased week-over-week in the second week of August. Exactly what is driving the increase, I am not sure. I'll start digging in when the TSA releases more airport-specific screening numbers soon. 

Even with passenger traffic (maybe) continuing to recover, capacity moves by airlines reek of desperation for new revenue streams that do not compete with their existing network. Let's take a quick look at United's new point-to-point markets. 

In 2019, United carried very few, if any, passengers within their newly announced markets. The Cleveland markets are a bit of an outlier, but United did recently drop these routes only to add them back as "new" in the November schedule. There is nothing new or inventive about United's new routes. They are adding capacity into large markets in hopes to pay for fuel and maybe a little bit more.  

This increasing desperation by airlines might be a boon for the passengers that are traveling, but it is also the same revenue destructive behavior that rushed airlines right into previous bankruptcies. But right now, airlines are not able to make completely rational decisions. 

Airlines are locked at a semi-previous state status-quo in terms of airports served and employment levels. Even with voluntary employment exits, airlines are still burning a massive amount of cash and are looking at other carriers' honeypots to steal from. 

According to Edward Russell from thepointsguys.com, 75,000 airline employees have been warned their positions could be eliminated. If you've been in the industry long enough, you should know better than assume this is some political game. Yes, many of these jobs may be saved, at least temporarily, with another round of CARES funding, but airlines will have to shed employees to reduce cash burn and start to deleverage themselves. Just this morning, Southwest reported they've issued nearly $19 billion in new debt since the beginning of the year. This will takes years to pay down even in the best of demand environments. 

Even in the unlikely event carriers breakeven with cash by the end of the year (I'm not sold), they still will have a rough January and February to deal with before generating cash to start paying down the government loans and corporate bonds that were issued over the last six months. For those looking to understand previously reported cash burn rates, CrankyFlier had a great write-up here.

With voluntary employee furloughs and layoffs in addition to the involuntary actions that are likely coming October 1, we now have to turn to other cost reductions, airport closures. 

Let's take one of American's smallest investment stations in 2019 as an example. Tyler, Texas is just 102 miles to the southeast of Dallas. In 2019, American operated on average four daily regional jets from DFW into the city. Just four daily flights flying 102 miles generated almost $12M in network revenue for the carrier. Put another way, American needed $4,000 in network revenue per flight to keep themselves interested in the market. 

As I've stated before, it is impossible to know if American was making money in the Tyler (or any) market. But if they were making money before, it is unlikely they are making money now. This puts American into a difficult position with airports such as Tyler. With no other legacy carrier operating in the city, there might be some ability to yield in the market. On the flip side, if they were to exit the city, it is likely some of the passengers would just drive to DFW or Love Field. Any cash burn from the city would largely be eliminated with the some potential to recapture some of the lost revenue. 

I do want to be clear, I am not saying American is leaving Tyler, I just want to use them as an example of the complicated decisions entering network planners minds. 

So where will airlines start to cut capacity? If you are worried about your airport consider the following two conditions as major red flags. If your airport ended up on the DOT service exception list, even if the airline was originally denied or pulled the request, consider your self warned. Melbourne, consider yourself forewarned. Finally, if you have another peer airport within close proximity and your airport has significantly less service than the other airport, there is a good chance you are on someone's list. 

Sorry, folks, unlike the past, I will not be generating my list of cities that are most likely to be impacted. The reasons are actually simple. City exits are extremely political (see Delta's attempt to close MLB). The last thing I want to do is stir up an unnecessary firestorm. Additionally, there are a lot of consultants out there that should be advising their airport of the current risk environment. They do not need free consulting work from me. 

Regardless of any additional rounds of funding from the government, airlines need to shed underperforming assets and costs. If we continue to keep completely unnecessary capacity flying, it will only hurt the industry in the long run. It is time for carriers to start making difficult decisions and clean up underperforming cities. After that, we will likely see a long period of stagnant growth from our large carriers as they reduce their debt and defer new capital expenses associated with new aircraft. This could set the stage for rapid growth for any new carriers if they can get off the ground. 

Networks Are Stabilizing: What About Cities?

The last five months (it's only been five months?) have been rough. Right now, we are currently in a cycle where legacies are rolling out massive cuts every couple of weeks. If you only read capacity change reports every couple of weeks, you would likely feel like the industry continues to spin in a downward spiral. While it often feels this way, I'm here to tell you airline networks are stabilizing. Yes, really. 

As an industry, network capacity has stabilized since July to around 14,000 average daily flights and 1.6M average daily seats. While this is nearly a 50% reduction in capacity, year-over-year, we are not seeing the continued decline in network capacity as we were seeing in March thru May, nor do we see a recovery that we saw in May thru July. Instead, we are stable at our 50% year-over-year decline. However, this stability is a hard pill for all of us to swallow with WARN notices spread across the industry. 

While I would expect some additional pruning of September capacity, I believe most of the legacy capacity was finalized over the weekend. If there are more substantial cuts coming, expect them from more point-to-point carriers such as B6, WN, and F9 as well as HA.

As networks have stabilized, legacy carriers have invested and often restructured their hubs. Since American's merger with US Airways, American has focused on building large, peaking banks rather than flatter rolling banks of the American-past. 

Let's take American's most bank dependent hub, Charlotte. Before the pandemic, American was running nine distinct banks within their CLT hub. Just two months later, American had gutted the structure to only four slightly smaller banks. American clearly positioned these banks within the core of the day as well. 

By July, seven of the banks had returned. Interestingly, these banks were largely restored to their March size, just fewer banks overall. As an example, the 9:30 departure bank peaks at 60 departures in both the March and July schedules. Finally, by September, the hub is still working with seven banks; however, American continues to adjust the bank sizes. The first two banks are slightly larger than their March compares, while there appears to be some horse-trading in the middle three banks. 

Delta, on the other hand, had historically used a blended, rolling bank within its Atlanta hub. Using March as an example, Delta only has a few peaks within its structure. Instead, there is more a continuous feed of flights throughout the day. However, by May, the rolling hub was gone, and Delta had switched the hub entirely to eight mini-peaked banks. Clearly, Delta was attempting to generate as many connections as possible for each flight. 

By July, each of the banks grew by at least ten additional flights with limited flights between each of the banks. This starts to change in the September schedule. In the September schedule, we can see Delta's willingness to grow outside of the peak bank structures starts to grow. 

While network planners are rebuilding banks, they are also examining how hubs are interacting with each other. Hopping back over to American's network, the makeup and proximity of CLT, DCA, and PHL to one another could create duplicate capacity on the network. As a planner, you are already competing with other carriers for scarce demand. You really do not want to be competing against yourself as well. 

When we examine American's leg passenger make up at CLT, DCA, and PHL, we quickly notice two things. One, from an absolute passenger count, CLT is massive compared to DCA and PHL. However, in terms of local passengers, all three hubs are roughly the same size. 

However, when we dig deeper, American is clearly treating each of these hubs independently. In September, DCA will only be operated at 29% of its last year's schedule. This compares CLT and PHL scheduled at 71% and 55% of their prior-year domestic trips, respectively. 

The significant DCA capacity decline is only possible thanks to FAA slot usage waivers that are currently extended through the end of October. Given the current level of passenger demand, I have to believe we will see the waiver extended at least thru the end of the year. With the September schedule, year-over-year, American will exit 21 markets and isolated their higher frequencies to American hubs, focus cities, and Portland, Maine. To be honest, I don't understand the last one. I suspect this might be an operational requirement, but it is difficult to know. 

When we take a look at the markets that American discontinued in September, we will quickly see two themes. Either American believes these markets can be recaptured, primarily via CLT or PHL, or American decided that the quality of the market demand is too low to warrant competing on these O&Ds. 

When we review both PHL and CLT, it is clear each of the cities offers distinct connecting patterns. When considering hub structure, PHL connects a lot of the Midwest and Mid-Atlantic to the Northeast and Europe (when it becomes available again...). PHL does overlap some with Northeast to Florida connectivity as well. 

CLT, on the other hand, offers a much larger breadth and depth of markets connecting the Midwest, Southeast, Florida, Mid-Atlantic, and the Northeast. This allows for robust connectivity and operational redundancy should it be needed. 

Interestingly, other than HPN, we do not see any domestic exits from CLT year-over-year. The reductions we do see are nearly entirely isolated to the number of banks planned this September vs. last September. 

This is likely a function of how American's network planners have structured the operation. Notice, CLT has limited Chicago and Dallas overflies. This again limits the amount of unnecessary redundancy within your own network, which would cause hubs to compete with themselves. 

While most hubs are starting to see capacity return, I do believe within the next month, barring an extension of the CARES Act, we will begin to see airlines remove spoke cities from their networks. If your city ended up on any of the carrier's DOT wish list, even if they are still operating there today, I would consider those cities the some of the first to be removed. 

Unfortunately, after that, we only need to go to our latest recession to see the standard targets, co-termed cities and small markets. In our next post (8/19), we will take a look at what airlines have historically dropped during network contractions. By then, it is very likely we will see Delta publish their revised October schedule, which is when CARES obligations expire and airlines can remove cities entirely from its networks. 

Delta's Cuts: Where's Everyone Else?

When Friday's schedule load was processed, it was clear airlines were starting to publish more realistic September schedules. Delta led the pack with the most capacity reduced week-over-week for September travel. In total, Delta removed 1,659 domestic flights per day or 36% of the week's September schedule. But as we discussed last week, what airlines had filed in September and beyond was a fantasy. 

We showed that before Delta's reduction, September was scheduled to be the highest number of expected seats since March 2020. Even as the industry showed some signs of recovering, for September seats to be higher than any month, especially all of the summer, would put us in the Twilight Zone. 

All of this surplus fall capacity is in a stalling recovery environment. As I predicted, we are starting to see TSA screenings flatten year-over-year. In the last three weeks, the seven-day moving average has stalled at -74% year-over-year. Unfortunately, if our forecast is correct, we may start to see a decline in screenings beginning around the second week of August and continue through September. 

  

Jumping back to Delta's schedule, the cuts should not catch anyone by surprise. The fall was and continues to be frothy. But Delta's cuts, as well as American's and United's are on a schedule. For August travel, Delta began their large cuts seven weeks before the start of the month, cutting domestic seats by 36% vs. what was filed the prior week. This is the same approach that Delta took with September, both in terms of timing and percentage seat decline. Further, Delta continued to adjust their seats downward another 12% between two and six weeks before the start of the month. I suspect we will continue to see this approach as Delta's revenue management analyzes booking trends.  

This raises the question, why have we not seen other large legacy carriers cut September similar to Delta? Well, its a week or two ahead of time before we would see those changes. Taking a look at American, American cut their August capacity in two waves: one at eight weeks out and another cut at four weeks out. If we take a look at September capacity, we see September's first, albeit a more significant reduction eight weeks prior to the month. It appears logical that we will see another round of cuts, not this Friday, but next Friday. The reductions could be loaded sooner due to American's earnings call is this Thursday. 

Interestingly, United follows a nearly mirrored pattern of American's capacity cuts at the system level. Like American, United started their first capacity cut at eight weeks out, with a much more aggressive cut at four weeks out. In United's earnings report, the carrier stated they expected capacity to be down 65% in the third quarter, so there is little reason to believe there will be a dramatic shift in United's September and October capacity patterns. 

Beyond the legacies, we are starting to see significant cuts at the smaller carriers. Over the weekend, Spirit cut 54% of the domestic capacity in September. This dramatic reduction is off-trend for Spirit and could raise red flags at the macro level. However, Spirit schedule is a prime example of worst-than wishful thinking and should have been removed quite some time ago. 

What do I mean? In the August schedule, Spirit waited until the absolute last minute to remove capacity from their domestic network. With only three weeks before the first August departure, Spirit removed 44% of their August flights. 

If other carriers are doing this, why am I singling out Spirit? American, Delta, and United have hub structures in place. While passengers might get displaced from their original flight, few will experience a significant change in their travel plans (i.e., nonstop to connecting). Spirit does not have the network structure to accommodate passengers into their original booked experience. Passengers booking Spirit to fly nonstop will likely find themselves connecting on Spirit (who doesn't have great connections) or being entirely canceled and refunded their booking, just three weeks before their flight. Either of these scenarios were completely unnecessary.

Spirit's schedule was never remotely realistic. While all carriers have bloated fall schedules (and they should all be publicly shamed for it), Spirit continues to publish a 17% increase in flights year-over-year for the fall. It has been evident since April or May that growth for the year was not in the deck of cards for anyone. Spirit had plenty of time to rebuild their network but failed to make the necessary modifications until the last minute and only for a month at a time. 

Finally, I want to take one quick look at another substantial capacity reduction, Alaska. In the latest schedule load, Alaska removed 38% of their September domestic seats. The cuts are spread throughout the system, hitting all major hubs (SEA, PDX, SFO, LAX, SAN, ANC). However, we can see Alaska starting to entrench around Seattle, with the main hub down only 26%. PDX and the California cities were down 40-50% in seats. 

Similar to Spirit, Alaska waited until the last minute to cut August. Unlike Spirit, however, Alaska has the depth (and now codeshares) to recover passengers much more with significantly less strain. Additionally, Alaska is pushing their cuts earlier into the booking curve.

 

As we progress closer to the fall, we will continue to see cuts from all carriers. And the numbers will likely be headline-grabbing, however, it is important to keep everything in context. Carriers are just now reducing their largely untouched fall and fourth quarter schedules. In terms of overall trends, capacity will likely be flat to up vs. summer capacity. 

As carriers start to work through the October schedule and beyond, the only outstanding question is which cities will stay on the network. Airlines that accepted the CARES Act funding can start dropping cities starting October 1. After that, I think it is anyone's guess if carriers start hacking off full appendages. 

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A couple of house keeping notes. Thank you for sticking with me even after my sabbatical. 

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One Way or Another, Expect More Capacity Cuts

In last week's post, we highlighted TSA screening data that hypothesized both a lopsided summer recovered and forecasted upcoming demand weaknesses for travel in August and September. Over the weekend, domestic carriers started to back off many of their recent capacity increases, as well as started reducing early fall capacity as well. 

While these capacity reductions, which we will discuss, look dire, it is important to remember that the fall capacity window still has a lot of fat to trim compared to the summer. What do I mean, well, if September were to fly today September 2020 would have 60% more seats flown vs. July 2020. Typically, September capacity decreases as summer travel wanes from a more leisure focus to more business or required travel.  Last year, the largest carriers flew 10% fewer seats in September compared to July. 

As we discussed last week, the summer recovery appears to be leisure-focused. Leisure dries up significantly starting in the first week of August and declines through September. So, with a lack of business-related bookings, there is little reason to expect significant growth in the fall.

 

On Tuesday, Delta had their first earnings call since everything came apart. In an interview on CNBC, Ed Bastian stated Delta sees similar trends. According to the interview, summer volumes are roughly 20-25% of average volume, mostly due to relatively good, but stalling, leisure demand. Business, on the other hand, is around 5%. It is unclear in the interview if he means business is 5% of total bookings or 5% of the previous year. 

In the last two weeks, airlines have started to decrease their capacity, but all of these cuts are targeting August through September. Even with these reductions, capacity does gradually increase from ~50% down year-over-year in early July, to 25-30% down year-over-year in early September.  After Labor Day, seats are flat to up, year-over-year. 

As we dig deeper into the August values, we notice that most of the network carriers are currently scheduled to fly with 40-50% fewer seats in August. Southwest is the outlier dragging the entire industry capacity up. Southwest is currently expected to be down *only* 10% in seats. Considering the continued delays from the MAX flying and general conservative nature of their leadership to product their balance sheet, this honestly surprises me. 

With generally all carriers stating demand has started to plateau, Southwest's off-trend capacity approach doesn't add up to me. While it would be possible that Southwest sees a higher traffic return than other carriers, I do not believe this to be the cause. When we isolated predominately Southwest airports (DAL, OAK, MDW, and HOU), TSA screened passengers are only recovered to -75% year-over-year. I cannot imagine being down 10% in seats for August is sustainable.  

 

But, compared to other carriers, Southwest might be completely stuck with this situation. For those that know the Southwest network well, it can be best described as a giant spaghetti monster. What do I mean? Southwest does not have hubs, nor are they exactly a point-to-point carrier either. This causes the carrier not to have hubs in which aircraft can be terminated without impacted multiple down-line flights. This is generally not as difficult at network carriers or nearly pure point-to-point carriers such as Allegiant. 

The picture above is 10 random Southwest planes operated on March 10, 2020. 

When the virus started to impact customer demand, all carriers were forced to make day-of cancellation decisions. This was expected, given the dramatic decline in customer demand. Southwest canceled over 50% of its scheduled flights throughout much of April 2020. While all carriers saw a ramp-up in day of cancellations as well; however, others were able to more immediately cut their scheduled flights while Southwest was more delayed until late April and May before they were able to enact sustained cuts. 

If Southwest has bet wrong on the August schedule, it would not surprise me to see a spike in day-of-cancellations throughout the month. 

But it is important to remember, too much capacity in the fall is not just a Southwest problem. All major carriers are running extremely hot with capacity immediately following Labor Day. With lagging demand, we should expect to see capacity cuts start rolling in soon. 

As these capacity are announced, which I believe we will hear updated guidance anytime now, it is essential to note that even substantial capacity reductions could still keep airlines larger than they were in June and July. Until then, we all wait uncomfortably together.