Wednesday, August 19, 2020

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



Wednesday, August 5, 2020

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.