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No Such Thing as a Free Lunch on Major Airlines
The major airlines are aiming to boost their profitability through the raising and initiation of new ancillary fees, such as those charged for baggage and other unbundled services not included in the price of the airfare. For reference, at UAL Corp. (UAUA), owner of United Airlines, these high-margined revenues rose $141 million in 2009, to around $1.1 billion, despite an approximate 7% falloff in air traffic and a $3.9 billion overall top-line decline. Thus far during 2010, carriers are still tacking on additional charges for previously free items.
Value Line Air Transport Industry participants currently include five major legacy U.S.-based airlines: Delta Air Lines (DAL), AMR Corp. (AMR), American’s parent, UAL, Continental (CAL), and US Airways (LCC). There are also a number of smaller regional entities, the largest being Southwest (LUV). The major carriers have been struggling to be profitable in recent quarters, due to elevated oil prices, and an ongoing influx of competition on domestic routes that is restraining airfares. One method of offsetting earnings pressure has been to boost ancillary fees, in addition to cutting available seating capacity and forming alliances.
The transport of bags is the primary service charged for by airlines. Currently, most domestic airlines ask for $20 to $25 for the first checked bag. Alaska (ALK) is apparently the most recent U.S. carrier to waive its free policy and begin charging for the first checked bag. JetBlue (JBLU) and Southwest are the only two remaining U.S. airlines offering this service for free. This policy is made possible by their more efficient operating structures, utilizing point-to-point route systems, versus the traditional hub-and-spoke model. Carry-on bags, meantime, have always been allowed for free, and continue to be. That said, Spirit Airlines (not covered by Value Line) this year announced the addition of a carry-on bag fee of up to $45 beginning on August 1, 2010. It is unlikely that the remaining carriers will jump on this idea in the near term.
A second item air travelers are now more apt to be required to pay for is food. Notably, on April 1st, Continental became the last major carrier to launch such fees. Carriers generally ask for $2-$5 for a meal. Again, JetBlue and Southwest, in addition to a few lesser-known airlines, namely Midwest and Hawaiian, remain holdouts in this regard. Alcoholic beverages, conversely, always command a fee, typically $6.
Finally, in terms of free airline amenities, there is the matter of blankets/pillows. In this case, there usually is no fee, with several exceptions. A “sleep set” on an AMR flight will cost $8. Passengers on Allegiant (ALGT), JetBlue, US Airways, and Virgin America flights will also be required to pay for these items, possibly because most of these carriers’ flights are short haul.
It is clear that the existence of free items on flights is diminishing. In fact, one carrier even has proposed the idea of charging for the use of on-board toilets. The airline, Ryanair, is having difficulties gaining approval for the plan, though.
Overall, we estimate that most Air Transport industry players’ ancillary top lines will climb again this year. At the leading ancillary revenue generator, UAL, that per-passenger amount rose by 4.5% in the first quarter. Still, the positive effect on margins is likely to be relatively modest, as, even for UAL, ancillary revenues remain only about 7% of the total.
The small amount of revenue actually generated by these fees, however, raises the question of how far the airlines can push their customers before the already negative image these firm’s have gets tarnished beyond repair. Clearly, charging for bathroom privileges is beyond the reason of most people, but some might put carry-on luggage in that same category. We believe that airlines are going to have to find a balance. What is clear is that some industry participants, such as JetBlue, are using the current trend of frugality to their advantage.