NEWSWIRE - MARCH 20, 1998
Topic:
Financial Forecasting
Source:
"Airlines Pocket Huge Savings on Fuel Costs,"
by Susan Warren, Wall Street Journal, Wednesday, March
20, 1998, page B1.
Synopsis of Article:
The airline industry is receiving a major boost in its net
profits this year due to a significant decline in the price
of one of its most important and most volatile cost items:
fuel. The strong domestic economy also means that demand for
airline services is robust. The result: revenues are up, costs
are down and many industry analysts are revising their estimates
of EPS upward.
Specifically, fuel costs have declined from
their 1996 level of $0.70 per gallon to a current level of $0.39.
For United Air Lines, this translates into a $30 million increase
in operating profit and a $0.17 increase in EPS. But why haven't
airlines reduced fares? Because they don't have to! The average
flight is 70% full and robust demand, particularly from business
travelers has allowed those fares to rise by 16% since 1996.
While fare increases have slowed down in recent months, some analysts
expect another increase of 6% for business fares during 1998.
The only "winners" are leisure travelers who are expected
to find their fares essentially unchanged in 1998.
Beyond the analysis provided in the article, this is a good vehicle for considering
other critical factors affecting profitability in the airline
industry. Here is an industry with enormous fixed cost components
associated with the financing of equipment. As a result, a
small downturn in demand or a modest reduction in variable
costs (such as fuel) will provide a disproportionate bump
in profits and EPS. This underscores the importance of the
sales and financial forecasting for the airline industry as
well as the impact of leverage.
Note: Perhaps airline executives showed prudence in resisting a cut
in fares. The Tuesday, March 23, 1998 Wall Street Journal
carried several articles describing the one day crude oil
price increase of 13%. OPEC producers have agreed to curtail
production of crude oil in order to raise the market price.
Clearly, this will take some of the optimism out of airline
earnings estimates.
Questions:
1. Why haven't fares dropped although fuel costs are down
significantly for the airline industry?
2. Although not mentioned directly in the
article, what are the major cost factors for an airline? Which
of these are fixed and which are variable? Does this industry
have a high degree of operating or financial leverage?
3. If you were forecasting revenues for an airline using
the linear regression approach on pages 598 and 599, what
would be good choices for explanatory variables?
Return to news index
|
