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Travel chaos compounds airlines’ cost problem

Leaving the pandemic behind is going to cost airlines more than they thought.

American Airlines was forced to scrub over 1,900 flights last weekend, due to a combination of wind gusts and staffing problems, echoing two previous episodes involving Spirit Airlines and Southwest Airlines. The risk of further travel chaos is part of the reason why, during this latest earnings season, all major U.S. carriers scaled back their ambitions for the next quarter and the first half of 2022.

World economic growth is decelerating, and it is hard to know how much of it is down to supply problems versus weakening consumer demand. The airline industry is suffering from both: Covid-19 variants have delayed the recovery for business and international travel but, even at lower capacity levels, it has proven hard to fill the shoes of all the workers who were urged to retire early or take leaves of absence in the depths of the pandemic.

A notable case is budget leader Southwest, which Wall Street analysts previously expected to fly almost the same fourth-quarter capacity as two years ago, according to the median forecast collated by analytics firm Visible Alpha. During its latest results presentation, the Dallas-based airline suggested that capacity would actually be 8% and 6% lower this quarter and next, respectively. Southwest is hiring aggressively, but “2022 capacity planning reflects more conservative staffing assumptions,” Chief Executive Gary Kelly recently told investors.

The key takeaway is that unit costs will increase more than previously believed, because the fixed expenses of operating planes need to be spread over lower ticket revenues. Delta Air Lines’ cost per available seat-mile excluding fuel, for example, is now expected to be 7% higher in the fourth quarter relative to the same period of 2019, whereas analysts’ previous forecast was for it to be lower.

Also, a 130% year-over-year rise in the price of jet fuel—which can make up as much as a third of airline expenses—may dash hopes of a profitable final quarter of 2021 for many carriers, including Delta.

To be sure, airlines have historically passed fuel-price increases on to customers within approximately three months, official data shows. Likewise, staffing problems will ease in the medium term. And since the Dow Jones U.S. Airlines Index is down more than 25% since the start of the Covid-19 crisis, compared with an almost 40% gain in the S&P 500 index, a lot of pain may already be priced in.

Still, the investment case for buying airline stocks relies heavily on Covid-19 acting as a catalyst for networks to be optimized, labor contracts to be renegotiated and extraneous fat to be cut. Permanently lower costs would allow for a return to 2019 profitability levels even if business travel remains weak. So far, this thesis remains hard to square with present reality. Brokers have been losing faith: Unit cost estimates for 2022 and 2023 have risen back toward 2019 levels. Another problem is that pricier airfares could sap demand for tourism.

Companies often overuse Winston Churchill’s famous advice to never “let a good crisis go to waste.” When it comes to hopes for a revolution in airline costs, investors should remain skeptical.

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