Saturday, April 02, 2005

Continental Airlines--Load Factor up 5.6% YOY

Continental Airlines

The year over year load increase at Continental was outstanding, up 5.6 points to 81.3%. The domestic load factor of 82.2% was particularly strong, up 7.3 points. International brought the overall number down as the increase was only 2.9 points.

Folks a 5.6% increase or even a 2.9% increase in load is a real good number for a trucker, airline, hotel chain or any other business that has a high operating leverage. Each time the load factor goes up, the ability to charge more goes up. Consider a hotel or airline that has 100 rooms or 100 seats. Assume the current charge is $100 per night or $100 per seat. Assume the occupancy rate or load factor goes up 5.6 points to 81.3%. Assume the lower vacancy rate allows the hotel or airline to charge all customers 5% more. The revenues prior to the increase were 75.70 times $100 or $7,570.00 per night or per flight. After the increase, the revenues would be 81.30 times $105 or $8,536.00 per night or per flight. The total revenue increase in the example would be 12.7%; which is still only half the equation!

If the company has a break even level of $7,000 per night or flight the increase in profits would be substantial. Most of the costs of the rooms or the seats are fixed costs. The extra cost per night might only be $5 per night or per seat and this is only for the newly occupied rooms or seats. The total cost increase would be only $5 times 5.6 or $28. The operating profits would have climbed from $570.00 per night to $1,508 for a profit increase of 264%!

Friday, several airlines, including Continental, raised fares; the 4th time this year! Yes, the excuse given was to off-set fuel costs, however, the ability to raise fares always depends more on demand than on costs. Competing airlines are more inclined to go along with an increase if they all are under costs pressures; for the fares to stick, demand must be present.

The stock and bond markets have been whipsawed in recent months. This point in the business cycle is always a time of confusion; this cycle is trying the patience of many. This market can do a 180 twice in the same day.

Friday's action illustrates the point. The job report was weak; interest rates declined, the dollar declined and stocks and bonds soared; later in the morning, the ISM report was strong; the dollar strengthened, interest rates went up and stocks and bonds stumbled. Random Roger wrote a piece called "Befuddlement".

Many market mavens were confused by the weak job numbers. They asked, How is it possible that we have a super-strong GNP and weak job growth at the same time? (After adjusting for inflation, we are experiencing wonderful GNP growth of 3.8%--which means business non-inflation adjusted top-line growth will be about 5.8%--which means profits will be better than projected. The whole economy enjoys operating leverage; not nearly as high as the airline business, but profits are going up faster than revenues.)

The globalization of the economy provides an indeterminable but significant part of the answer to the strength vs. weakness question. We should not expect strong job growth in the US while much of the developed world is flirting with recession. The latest Germany unemployment rate was 12%! Industrial production and employment is weak through most of Western Europe and Japan is also flirting with recession.

The other half of globalization is that we should not expect to have strong employment growth in the US while we are actively exporting low wage labor intensive manufacturing to developing nations. It is hard to bring this factor up without mentally hearing the whining. Those who lost their job knitting socks in American are not easily convinced that it is better for all to have the socks made cheaply in China, even though it is. There will be employment growth in the US as a result of the trade with China. In fact, the jobs created in America will be better jobs than the ones lost. The total number of jobs created in China will exceed the number created in the US but the US total employment will expand.

The other significant but indeterminable factor relates to technological changes. These changes show up in productivity and in lower inflation rates. Many folks are confused about inflation. They know that many of the things they buy every week cost more and more, but they often do not appreciate the substitution effect which works to constantly lower prices.

You are currently reading words typed onto and "electronic page". Surely you can appreciate that these words were delivered to you for much less than if they were printed on newspaper and delivered to you. The walls of a home today use only a fraction of the resources used to make the walls of a log cabin. The substitution effect is currently dramatically lowering the costs of phone calls, information delivery, banking services, brokerage services and much more.

Productivity is also frequently misunderstood. The cost of any product is the total cost from the very idea of the product all the way to the warranty work that might be done years after the sale. There are many steps to making any product and thus much communication is required. The information revolution has changed and is changing the entire process of creating a product.

Continental Airlines has dramatically cut the costs of providing its services. The recent deal with several unions cut costs by $418 Million per year. This major reduction is by no means the total reduction. Commissions for the sale of tickets have been reduced dramatically as more and more tickets are sold direct to consumers online. Code sharing arrangements allow Continental to sell multiple connections on many participating airlines. Employee training costs have been reduced. The list goes on and on.

The airline business and most other businesses in America are cutting costs and increasing revenues at the same time; an ideal environment for stocks. The highly leveraged companies that survive the worst of times make the most in the best of times. Here is to high load factors and inflated ticket prices; let the good times roll.