U.S. Airlines:U.S. Airlines:Global Competitiveness and Industry ViabilityGlobal Competitiveness and Industry Viability

John P. HeimlichJohn P. Heimlich

VP and Chief EconomistVP and Chief Economist

www.airlines.org

OVERVIEWOVERVIEW

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• DOT mission explicitly recognizes importance of airline viability/competitiveness

• A viable, competitive U.S. airline industry is good for the country, fueling jobs and growth

• Numerous stakeholders benefit from a financially viable, competitive U.S. airline industry

• From a customer standpoint, the U.S. airline industry is unquestionably competitive

• The U.S. airline industry is financially weaker than other U.S. industries

• U.S. airlines are financially weaker than most non-U.S. airlines

• The domestic market has matured; the battlefield has shifted to the global stage

• To reinvest in product/people, U.S. airlines need substantially improved finances

• Competing effectively in global market is essential to airlines and good for the USA

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DOT Statutory Mission Explicitly Recognizes Importance DOT Statutory Mission Explicitly Recognizes Importance ofof

(and Role in) Industry Viability and Competitiveness(and Role in) Industry Viability and Competitiveness U.S. Code, Title 49, Sec. 40101. Policy, Subsection A: “Economic Regulation”

(6) placing maximum reliance on competitive market forces and on actual and potential competition — (A) to provide the needed air transportation system; and (B) to encourage efficient and well-managed air carriers to earn adequate profits and attract capital, considering any material differences between interstate air transportation and foreign air transportation.

(14) promoting, encouraging, and developing civil aeronautics and a viable, privately-owned United States air transport industry.

(15) strengthening the competitive position of air carriers to at least ensure equality with foreign air carriers, including the attainment of the opportunity for air carriers to maintain and increase their profitability in foreign air transportation.

(16) ensuring that consumers in all regions of the United States, including those in small communities and rural and remote areas, have access to affordable, regularly scheduled air service.

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A Viable, Competitive U.S. Airline Industry Is Good for A Viable, Competitive U.S. Airline Industry Is Good for The Country, Fueling Jobs and Economic GrowthThe Country, Fueling Jobs and Economic Growth

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“Aviation is the glue that keeps the global economy together. Without widely accessible and well-priced air travel, the global economy will quickly become less global.”

— Dr. Mark Zandi, Chief Economist & Co-Founder, Moody’s Economy.com (August 2008)

$1.225 trillion/year in economic activity

$371 billion/year in personal earnings

10.9 million jobs

“The Economic Impact of Civil Aviation on the U.S. Economy” (FAA, Dec. 2009)Commercial aviation helps

drive:

Commercial aviation contributes: $731.5 billion/year to U.S. GDP 5.2% of U.S. GDP

“Economic growth and prosperity are determined in large part by access to the global economy. And, just as islands require bridges to the mainland….communities require bridges to the global economy. Air transportation is that bridge, providing the necessary access for U.S. cities…to enjoy a ‘Virtuous Circle of Economic Growth.’”

“The Plane Truth About Air Service and Economic Development,”Global Aviation Improvement Network, Booz Allen (March 2001)

“Every day, the airline industry propels the economic takeoff of our nation. It is the great enabler, knitting together all corners of the country, facilitating the movement of people and goods that is the backbone of economic growth. It also firmly embeds us in that awesome process of globalization that is defining the 21st century.”

— Daniel Yergin, Author, Commanding Heights: The Battle for the World Economy, in the ATA 2005 Economic Report

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Commercial Aviation Drives Nearly 11 Million U.S. Commercial Aviation Drives Nearly 11 Million U.S. JobsJobs

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U.S. Job Impact by Aviation Activity, In MillionsU.S. Job Impact by Aviation Activity, In Millions

Source: Federal Aviation Administration, “The Economic Impact of Civil Aviation on the U.S. Economy,” (December 2009)

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Numerous and Varied Stakeholders Benefit From a Numerous and Varied Stakeholders Benefit From a Financially Viable, Competitive U.S. Airline IndustryFinancially Viable, Competitive U.S. Airline Industry

Continuity of Plentiful Service, Job Security, Reinvestment in Continuity of Plentiful Service, Job Security, Reinvestment in Product and PeopleProduct and People

Airline/Airport/Aerospace

Workers

Hub Cities

Spoke Communities

U.S. Treasury

Small Businesses

Corporate America

Aviation Suppliers

National Defense

Air Travelers and

Shippers

People Who’ve Never

Flown

Agriculture Interests

Manufacturing Sector

Importers/Exporters

Travel and Tourism

Humanitarian/Relief

Workers

Medical/Emergency

Personnel

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From a From a CustomerCustomer Standpoint, Former DOT Officials Standpoint, Former DOT Officials Recognize the U.S. Airline Industry As Unquestionably Recognize the U.S. Airline Industry As Unquestionably

CompetitiveCompetitive

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“The purpose of this study is to examine the competitiveness of the U.S. domestic airline industry following a period of unprecedented financial turmoil and considerable change in industry structure…. [T]he industry is more competitive now than at any other time in the 12-year period examined.”

“One area of promise for the network airlines is the prospect for continued international expansion to provide support for their domestic networks. Although the airlines (and consumers) have benefited from the international network development enabled by the liberalization created by open skies agreements, the potential for much greater progress is large.”

— Former DOT officials Randy Bennett, Patrick Murphy and Jack Schmidt,“A Competitive Analysis of An Industry in Transition” (July 2007)

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Airline Industry ROIC Worst Among U.S. IndustriesAirline Industry ROIC Worst Among U.S. Industries Historical Average ROIC (Percent) in U.S. Sectors, 1963-2007

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SOURCE: Corporate performance database

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Healthy Investment Requires Healthy EquityHealthy Investment Requires Healthy EquityEquity Market Capitalization (Billions) as of August 2Equity Market Capitalization (Billions) as of August 2

* AAI, ALGT, ALK, AMR, CAL, DAL, HA, JBLU, LCC, LUV, MESA, PNCL, RJET, SKYW, UAUA, XJT

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Competing Globally Will Require Strength at HomeCompeting Globally Will Require Strength at HomeConstraining U.S. Carriers Domestically Will Have Lasting ImplicationsConstraining U.S. Carriers Domestically Will Have Lasting Implications

Source: ATA and Morgan Stanley

Net Profit Margins: Calendar Years 2007-2009

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S&P Corporate Credit Ratings (July 12, 2010) for North S&P Corporate Credit Ratings (July 12, 2010) for North American Transportation Companies, “Strongest to American Transportation Companies, “Strongest to

Weakest”Weakest”

1. Union Tank Car

2. UPS3. TTX4. AMTRAK5. Canadian

National Railway

6. Kirby Corp.

7. Burlington Northern8. Enterprise Holdings9. Norfolk Southern10. Ryder System11. Alexander & Baldwin12. GATX13. Union Pacific14. FedEx15. Hunt (J.B.) Transport16. Brink's Co.17. Aviation Capital

Group18. Canadian Pacific

Railway19. Southwest Airlines20. CSX21. Con-way22. ILFC

23. AWAS Aviation Capital24. Teekay Corp.25. AMERCO26. Kansas City Southern27. Mobile Mini Inc.28. Overseas Shipholding

Group29. Kenan Advantage Group30. RailAmerica31. Avis Budget Group32. US Xpress Enterprises33. Hertz Global Holdings34. Alaska Air Group35. Global Aviation Holdings36. Marquette Transportation37. United Maritime Group38. Delta Air Lines39. Ozburn-Hessey Holding

Co.40. American Commercial

Lines41. Horizon Lines42. General Maritime Corp.43. Continental Airlines

44. Dollar Thrifty Automotive

45. UAL Corp.46. Coach America

Holdings47. JetBlue Airways48. AirTran Holdings49. JHCI Acquisition Inc.50. Quality Distribution

Inc.51. Trailer Bridge Inc.52. Western Express Inc.53. AMR Corp.54. US Airways Group55. Air Canada56. Swift Corp.57. Evergreen

International58. YRC Worldwide

AA- to A- BBB+ to BBB-

BB to B B- to CCC-

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U.S. Airlines – “Low Cost” or Otherwise – Cannot Justify U.S. Airlines – “Low Cost” or Otherwise – Cannot Justify Growth or Reinvestment Without Substantial Gains in Growth or Reinvestment Without Substantial Gains in

ROICROIC

“…LUV...reiterated that it does not intend to grow its fleet significantly until its financial goals, including a 15% ROIC are in sight. On a rolling 12 month basis, LUV’s current ROIC is about 7%, including two tough quarters in 2H09... We do not believe LUV will seriously look at growing its fleet significantly until 2012 barring a double dip recession, jet fuel price spike or other ‘black swan’ events that often befall this industry.”

— Research Update (July 30, 2010), Michael Derchin and Ben Shim, CRT Capital Group LLC

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“We do not intend to significantly grow the fleet until our financial goals are achieved or in sight.”

— Southwest Airlines CFO Laura Wright, July 29, 2010 earnings release,citing the company’s goal of achieving a 15% pretax return on invested capital

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The Future Lies Across the Pond(s)The Future Lies Across the Pond(s)Thinking Outside the [Domestic] BoxThinking Outside the [Domestic] Box

Airbus Global Market ForecastAnnual Traffic Growth: 2009-2028

Boeing Current Market OutlookAnnual Traffic Growth: 2009-2028

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Airline Energy Costs Are High and Poised to RiseAirline Energy Costs Are High and Poised to Rise

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What’s Wrong With This Picture?What’s Wrong With This Picture?The Investor’s ViewThe Investor’s View

“The poor financial performance of the industry through full business cycles can be attributed to its high fixed cost structure, overleveraged balance sheets, low barriers to entry, high barriers to exit, fragmentation, and fierce competition from low-cost domestic carriers and recently-consolidated, well-funded international carriers in Europe, the Middle East, Asia and Latin America…

As you weigh policy objectives for the airlines, you may want to consider the benefits from having airlines in a better position to generate a return on invested capital in excess of their cost of capital through a full business cycle. The balance between positions which seek to socialize aspects of the airline industry versus those that promote growth in the free market will contribute to how the market prices airline capital risk and measures the required rate of return to justify growth. The ability to generate more consistent returns on equity and increase free cash flow is the path to repairing balance sheets and longer term financial stability. Only then will there be a solid foundation for increased capital expenditures, rising wages, and increased service.”

— Statement of David R. Strine before the House Transportation and Infrastructure Committee Subcommittee on Aviation,

“Consolidation In The Aviation Industry, With A Focus On The Proposed Merger Between United Airlines And Continental Airlines –

A Perspective From Within The Financial Markets” (June 16, 2010)

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Where Do We Go From Here?Where Do We Go From Here?

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To invest in people and product, airlines require sustained profitability – they must earn their cost of capital over the entire business cycle

U.S. airlines are climbing out of a deep hole – doing better financially should not be equated with doing well (or well enough) financially

By just about any measure, U.S. airlines are less equipped than other airlines and other industries to compete effectively on the global stage

Barriers to exit, higher taxes, environmental charges, inefficient infrastructure (air traffic control vs. air traffic management) will exacerbate inadequate financial condition and the competitiveness gap

Consistent with DOT mission, promoting and encouraging the development of a viable, competitive U.S. airline industry is in our national interest

www.airlines.org

DOT Statutory Mission Explicitly Recognizes Importance DOT Statutory Mission Explicitly Recognizes Importance of Industry Viability and Competitivenessof Industry Viability and Competitiveness

U.S. Code, Title 49, Sec. 40101. Policy, Subsection A: “Economic Regulation”

(6) placing maximum reliance on competitive market forces and on actual and potential competition — (A) to provide the needed air transportation system; and (B) to encourage efficient and well-managed air carriers to earn adequate profits and attract capital, considering any material differences between interstate air transportation and foreign air transportation.

(14) promoting, encouraging, and developing civil aeronautics and a viable, privately-owned United States air transport industry.

(15) strengthening the competitive position of air carriers to at least ensure equality with foreign air carriers, including the attainment of the opportunity for air carriers to maintain and increase their profitability in foreign air transportation.

(16) ensuring that consumers in all regions of the United States, including those in small communities and rural and remote areas, have access to affordable, regularly scheduled air service.

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When America Flies, It WorksWhen America Flies, It Works