Aviation Disappointing summer could make for a very long winter By The staff of Travel Weekly / August 11, 2009 Share 1 -- This is the time of year when many travel companies, particularly airlines, generate their peak revenue. They make hay. But not this year. The recession has throttled demand for business and leisure travel, forcing airlines and other major travel suppliers to cut capacity, reduce costs and slash prices. For the first half of the year, revenue yields for airlines, hotels and cruise lines plummeted as the street price of travel kept falling, eating into what would ordinarily have been peak-season profits. It's a scary time for cash-starved travel firms, but it might not be as scary as what happens next. What happens next is winter. For the travel industry as a whole, it could be a long cold spell if, as many economists predict, we're having a U-shaped recession. Imagine a line graph representing an economic indicator falling, hitting bottom and rising again. In a V-shaped recession, the line hits bottom and bounces back sharply. In a U-shaped recession, you stay down there awhile. Given that travel tends to be a lagging indicator, usually following rather than leading a recovery, the U is a bad omen; it portends a prolonged period of weak demand, price cutting, eroding yields and declining revenue, well into the winter season and perhaps beyond. If that goes on for too long, it could result in a contraction. Commercial aviation Of the major travel industry supplier groups, the airlines seem already well on their way to that scenario. Most major U.S. airlines have hoarded enough cash for short-term contingencies but not for a prolonged recession, and certainly not if fuel prices do another dance. If those things happen, the result could be ugly because the airlines as a group will have few options. They've generated most of their current cash reserves not by operations but by borrowing, and they're tapped out. United even mortgaged its spare parts. According to an analysis of major airline liquidity by aviation consultant Darryl Jenkins, the total debt of the 10 largest U.S. airlines exceeds the national debts of countries such as Venezuela, Pakistan, Iraq and South Africa. In fact, the debt-to-equity ratio of the six legacy carriers is 106%, which is worse than the automakers. Yet throughout the second quarter, airlines relied on deep discounts and sale promotions to fill airplanes, even as they cut capacity. Yield, expressed as revenue per available seat-mile, was down about 16% in July compared with the year before. August could be just as bad, or worse, and UBS Investment Research analyst Kevin Crissey warned in his July 23 airline sector note to industry investors that "September could be the worst month of the year." JetBlue CEO David Barger put it this way in his quarterly chat with analysts: "We have continued to see negative pressure on yields during both peak and nonpeak travel periods." For many carriers the result is a boost in load factors, but history has shown that filling airplanes with money-losing fares is not a good long-term strategy. Carriers can offset some of the downside of discounting by charging more ancillary fees for things such as checked baggage service, but an industry that is, in Jenkins' words, "running on debt" will need an awful lot of ancillary revenue to pay its bills. Because of the cumulative effects of chronic overcapacity and external shocks such as fuel spikes and the recession, Jenkins said he believed the U.S. airline industry was "a long, long way from sustainability." A U-shaped recession, he said, would "create a lot of problems for a lot of airlines" and require significant restructuring of debt, either in bankruptcy or otherwise. It could reach the point, he said, where liquidating a major airline will be a good thing because, for this environment, "there are too many carriers." When the economy finally does turn around, Jenkins said, he expects to see "different behavior" from the airlines, with more disciplined growth, particularly in domestic markets. "They're not going to be expanding." Hospitality Something similar, though less traumatic, could be in store for the hotel industry. When the global economy first started its meltdown, the big question for the hotel industry was whether it would be able to hold prices and avoid rampant discounting. Almost a year later, the only question is: How low can rates go? In the first six months, according to Smith Travel Research, yield as measured by revenue per available room fell nearly 19%, a record drop. "There has never been a decline of this magnitude for this duration," said Bjorn Hanson, a professor at New York University's hospitality school. And Hanson said he sees no signs of that rate pressure easing. In broad outlines, the short-term challenge facing hotels is similar to the airlines' dilemma: To make up for a drop-off in business and meetings travel, hotels are slashing rates to lure more leisure travelers. Starwood Hotels and Resorts, whose brands include W, St. Regis, Westin and Sheraton, just ended a two-week global sale offering discounts of up to 50%. Properties throughout Colorado's Rocky Mountain ski resorts were offering rates this summer under $100. Las Vegas had room sales as low as $20. And the list goes on and on. "It is disappointing, surprising and a little bit sad," said Mark Lomanno, STR's president. From the beginning of the downturn, Lomanno has urged hoteliers to try to hold rates, because it takes years to get them back to their highs. "If you're looking at the last downturns, a lot of the commentary that we heard from the brands and the revenue managers is that they learned their lessons in 2001-2002 and they would be able to react better the next time around," he said. "For whatever reason, maybe because this downturn is so severe and so dramatic and so different than they were expecting, what they learned they weren't able to apply." Lomanno added: "Whatever the reason, the decline in pricing is more dramatic than it's ever been, more than we thought it would be, indeed more than we think it should be." Initially, hoteliers tried to avoid cuts to their base rates by introducing so-called "value adds" like a third or fourth night free, gift cards, spa treatments or meals. But as meetings business took a dive in response to the bailout-driven backlash against "junkets," rates kept falling, bringing in lower-yield leisure traffic to offset the sharp decline in business travel. Marriott International, for example, said that while corporate business was down 18% in the second quarter, leisure travel was up 12%. "Weekend occupancy was higher than weekday, a surprising statistic in the peak spring business travel season," said Marriott President Arne Sorenson. Until business travel picks up, Sorenson said, "we will continue to have pressure on rates." Hanson predicted that rates would likely keep falling through next year. Complicating the hotel picture is the lingering instability in the real estate market that could eventually reduce supply. Foreclosures on commercial mortgages are still rising, according to an STR report based on data from Trepp LLC, a provider of commercial mortgage information. At the beginning of 2008, only 0.5% of commercial mortgage-based securities were delinquent. By January 2009, that number had risen to 1.7%. Last month, it hit 4.2%, and it's still rising. Some of these hotels are closing. Others are not being built or are spending far more time on the drawing board than they used to. According to Smith Travel Research's Construction Pipeline Report, there were 4,690 hotels in various stages of development in June, accounting for half a million rooms, a 24.5% decline from the same month of 2008. The slowdown has stung the Caribbean and Mexico, where stalled resort developments pepper the region and low occupancies at existing properties have resulted in layoffs. "Our economies are suffering," said Maurice Odle, economic adviser to Caribbean Community Secretary General Edwin Carrington. "The tourists have been coming, but they spend less, and governments get less revenue. The governments are in trouble, and now they are trying to borrow." Some hotel and resort operators are also worried that by reducing rates now to remain competitive, they could be setting themselves up for a backlash, if consumers resent a return to higher rates once the recession is over. Cruise lines In a sense, the challenge facing the cruise lines in this recession is simple and familiar: Fill the ship. Even in good times, the economics of cruising starts and ends with a full ship to maximize economies of scale and maximize onboard revenue. Thus, job one was to find the price point that incentivized consumers in the midst of the worst economic collapse since the Great Depression. Apparently, the cruise lines are having some success. The largest are continuing to fill their ships, albeit at much lower prices than they have been able to demand over the last few years. Although Carnival Corp. posted a $264 million Q2 profit in June, it was down a third year over year, reflecting a 9.8% drop in net revenue yields. COO Howard Frank said it was a decline that many at Carnival had "never experienced." Norwegian Cruise Line reported in May that yields were down 7.9%, also a result of weak pricing. A Wachovia Capital Markets survey on cruise pricing in the second quarter revealed abysmal prices in some markets. Alaska cruise prices suffered the most, dropping as much as 40%. Even so, the deals are working. By all accounts, the mass-market lines are sailing full, and several of the luxury lines have said that booking levels are up. But the resulting yield erosion is forcing cruise lines to curtail shipbuilding plans and change itineraries. Fast-growing cruise line MSC Cruises said in July that it was putting the brakes on its rapid expansion. MSC has taken delivery of six new ships since 2001, with two more on the way. Travel sellers Travel agents are also feeling the pinch. Though many agencies are actually reporting better sales this year, they are earning less in total commissions because prices are so low. According to CruiseOne and Cruises Inc., transaction volume has increased this year, rising 9.6% during the 10-week period ending July 31. But the average selling price this year is down 10.8% compared with 2008. One large cruise seller said that while cruise prices have dropped significantly over the last year, those cuts have come from the commissionable part of the sale, and the noncommissionable parts of the cruise price have remained constant. That agent said that sales and profits through the first half of this year were similar to what they were in 1995 but added that it has taken just over twice as many transactions to do that same amount of business. Frank Del Rio, CEO of Prestige Cruise Holdings, parent of Oceania Cruises and Regent Seven Seas, said that he has been hearing weekly of agencies that are moving to a home-based model or going out of business altogether because they can no longer compete in the current environment in which cruise lines continue to cut prices. "Everyone lowers prices to stimulate sales," he said, noting that Oceania and Regent have chosen to add value such as shore excursions rather than slash prices. "It works, but it hurts the travel agents." Packagers Another potential casualty of falling retail prices is the wholesaler, the packager, the tour operator, whose general niche in the marketplace is to assemble a trip more economically and effectively than a traveler can. They are now faced with supplier prices that continue to drop, but they're reacting with widely varying strategies. Tour operators tend to resist discounting once their brochure prices are established. Once they hedge their currency rates and establish block pricing with suppliers, they have to commit to a brochure price for the following year. "There's not much discounting going on," said Scott Nisbet, CEO of the Globus family of brands, which owns the escorted tour brands Globus and Cosmos, the FIT program Monograms and the river cruise operation Avalon Waterways. He explained that even when hotel prices fall, perhaps even becoming dangerously close to the favorable rates that tour operators negotiate, there are many other components of the tour, including transportation, meals and attractions, that still contribute to the overall value. Nisbet added that when Globus does offer promotions, it is often in the form of discounted airfare. For many wholesalers and packagers, the situation is almost entirely the reverse. They often have to mimic the pricing trends of their suppliers, almost in real time. For instance, Travel Bound, an FIT wholesaler, adjusts the pricing on the thousands of hotels in its database automatically as the hotel rates change. As a result, wholesalers can hang on to their markets, but, said General Manager Nico Zenner, "We're not making the same margins." Mike Going, president of Funjet Vacations, said, "The average selling price of a package this year vs. last year is down about 10%. The good news is, these deals are having their intended effect, and volume is starting to look reasonable." Does that mean prices will soon stabilize? Going isn't sure. "For the balance of '09 and '10 ... I don't know that we will get all the way back to 2008 pricing or early-2009 pricing," he said. Looking across all sectors of travel, Forrester Research analyst Henry Harteveldt is not encouraged. He sees "a glut of supply" in every sector and fears that there's "not enough pricing Viagra out there to get this industry's pricing up to where it should be." Asked to cite the biggest problems, he said, "We have too many airlines" and added that the industry probably "needs to lose some of the hotels," too. Even then, he said, pricing stability could be three years away. Echoing the concerns of STR's Lomanno about the impact of price cutting on hotels, Harteveldt said that many marketers were looking at the wrong metrics, trying to boost load factors or maintain occupancy levels. The discounting that is necessary to do that, he said, "is creating the impression that travel ought to be dirt cheap." Once you take the consumer from $399 to $89, Harteveldt said, it takes a long time to get back. But when this recession ends, he said, consumers are "going to have a different relationship with their money," and there will be fewer people traveling. According to Harteveldt, the challenge for revenue managers is to find the price point where they can deliver value, be selective in targeting specific demographic or psychographic markets, and then "be prepared to be undersold.