Overview of the Domestic Airline Industry: September 17, 2001

1
Overview of the Domestic Airline Industry
September 17, 2001

• Darryl Jenkins, Director
• The George Washington University
• Aviation Institute

2
Current State As of September 10, 2001

• Current losses are forecast to be approximately 2
  to 3 billion dollars
  
• Oldest and most fuel inefficient planes will be
  retired (150 planes)
  
• Approximately 9 to 10 billion in cash

3
Current State As of June 1, 2002

• Cash shortfall of at least 10 billion dollars
• 500 planes parked
• There will be a ripple effect to air frame
  manufacturers, hotels, car rentals, etc.

4
Airline Economics Fundamentals

• Small changes make big differences
• During a very good year, airlines make money on
  only one to two passengers per flight
  
• Airlines are a cash flow business. Advance
  bookings keep the airline in business

5
Airline Economics Fundamentals

• To forecast the financial health of this years
  airline industry, we need to look at the
  determinants of demand and how they have been
  affected

6
Airline Economics Fundamentals

• The interaction of the airlines current
  financial condition with the new demand
  realities. This includes looking at how much cash
  they have on hand and can access in a short time

7
Determinants of Demand

• GDP, Fare levels
• Loss of consumer confidence (hoarding of cash)
• Fear of Flying, additional military action or
  terrorist actions
  
• Inconvenience of airport security measures will
  shift travelers to other transportation modes, if
  any

8
Net Worth

• Net worth is a good estimator for ability to
  borrow
  
• We use net worth minus intangibles minus
  impairment charges
  

FOR MORE INFO...
SEC Edgar figures June, 2001 Form 41 DOT
9
Net Worth

• Current negative net worth
• US Airways 1.8 billion
• Northwest airlines -606 million

10
Net Worth

• Small Net Worth
• Continental 200 million
• America West 200 million
• Air Tran 30 million

11
Net Worth

• Hard Assets to Borrow Against
• American 3 billion
• United 2.3 billion
• Delta 2.8 billion
• Southwest 3.8 billion

12
Cash Burn Rates

• Time Needed to Use up All Cash and Available
  Borrowings
  
• This assumes that the airlines can borrow and
  have no possible contingent liabilities (This may
  exclude United and American)

13
Cash Burn Rates (in Days)

• Southwest 309
• Delta 74
• United 81
• American 86
• Continental 15

14
Cash Burn Rates (in Days)

• Northwest 50
• US Airways 52
• Alaska 141
• America West 52
• Air Tran 15

15
Most Endangered Airlines

• Continental,
• Northwest,
• America West,
• US Airways,
• Air Tran

16
Most Endangered Airlines

• This group will likely file for Chapter 11
  bankruptcy within 30 to 60 days

17
Most Endangered Airlines

• Under best case scenarios, we might permanently
  at least one of these five airlines.

18
Second-Tier Endangered Airlines

• American
• United
• Delta

19
Second-Tier Endangered Airlines

• This group will most likely file for Chapter 11
  bankruptcy within 60 days

20
Second-Tier Endangered Airlines

• American and United will most likely have to file
  at some point due to potential liability
  problems, but will survive, with limited ability
  to grow.
• If the downturn in bookings exceeds 60 percent
  for more than two months, from current levels,
  all three of the majors will have to file chapter
  11 and will have troubles restructuring.

21
Third-Tier Endangered Airlines

• Alaska,
• Southwest

22
Third-Tier Endangered Airlines

• This group will most likely remain standing, but
  will have limited ability to grow. Under the
  worst case scenario, they would also suffer
  financial distress

23
What Happens When The Airlines Start Up Again?

• Fixed Costs are approximately 60 percent of total
  costs
  
• Variable Costs are approximately 40 Percent of
  total costs
  
• The high fixed costs are the reason for the
  current distress

24
What Happens When The Airlines Start Up Again?

• How big the losses are will be a function of
  travelers regaining confidence in the security
  process
  
• US Airways, TWA and ValuJet, after their crashes,
  lost approximately two months of bookings over
  the year The loss in bookings will certainly be
  larger than historical precedent

25
What Happens When The Airlines Start Up Again?

• How much more will traffic fall off?
• If we go into a recession now because of the
  events of September 11th, traffic will fall
  another 10 to 15
  
• This is the best case scenario (load factors in
  the high 40s)
  

26
What Happens When The Airlines Start Up Again?

• Best Case Scenario
• It may take six months to a year to get up to
  break-even load factors again (loss minimization
  strategy)

27
What Happens When The Airlines Start Up Again?

• The best case scenario has large loses, but some
  liquidity at the end of the year, with the first
  tier airlines filing for Chapter 11 bankruptcy
  protection
• Air Tran folds
• America West and US Airways have the most
  difficulty reorganizing and also fold

28
What Happens When The Airlines Start Up Again?

• The Worse Case Scenario
• High thirty percent load factors increasing to 40
  percent in January and gradually increasing
  thereafter to 65 percent by June

29
What Happens When The Airlines Start Up Again?

• 80 percent of airline revenue is domestic in the
  United States
  
• Growth areas were formerly international, which
  will be hit hard by military actions and
  uncertainty
  
• It is unclear how cargo demand will be affected

30
What Happens When The Airlines Start Up Again?

• Worse Case Scenario
• Both the first and second tier airlines file for
  Chapter 11 bankruptcy by this years end
  
• None of the first tier endangered airlines are
  able to reorganize
  

31
What Happens When The Airlines Start Up Again?

• How bad it will actually be is a function of how
  many people fall out of traffic counts due to
  lack of security confidence
  
• Generally, airlines bring travelers back by
  lowering prices after a disaster. This will be
  more difficult this time