Earnings season has officially begun with, as always, Delta kicking off festivities late last week and then United just yesterday releasing its numbers. The airlines unsurprisingly did very well, but the results and more importantly, forward-looking guidance, show that we may have finally seen a structural shift. Airfares are up, and I don’t imagine they’ll be going back down anytime soon.
On the surface, it looks like Delta is outperforming with an operating margin of 9.4 percent versus United’s 6.2 percent, but remember, Delta owns a refinery and that helped boost the company’s fortunes this quarter. Since today’s topic is about the core business, let’s try and strip out fuel’s impact.
- Excluding the refinery, Delta’s operating revenues were up 13.9 percent, below United’s 16.0 percent
- Fuel expense at Delta rose 67.2 percent year-over-year while United was up 84.1 percent
- Fuel went from being worth 55.8 percent of Delta’s largest expense — total salaries and wages expense — to 86.3 percent, but at United fuel soared to become the airline’s number one cost at 109 percent of salaries and wages
- Delta’s unit costs were up 21.4 percent, but excluding fuel, they were up only 6.8 percent while United’s numbers were up 15.2 and 6.1 percent respectively
You get it. Fuel is a big deal, and it was very messy in Q2 when the bulk of the Iran War was being waged. And yes, I’m well aware that it’s still being waged and probably won’t end anytime soon now that Iran has learned it can toy with the Strait of Hormuz whenever it feels like it. Just look at the downward slope reversing course recently.
And when fuel goes up, fares have to go up. In the past, this often meant cutting significant capacity thanks to basic economics, but that’s not happening now. And even when fuel came down off its highs, fares didn’t budge downward at all. Demand has been very strong, and it took an event like this to get airlines to actually be able to take real pricing increases for the first time in a long time.
To see what I mean, you can look at the Government Accountability Office’s new report on the impact of mergers. I sat with Courtney Miller as my guest host on The Air Show this week to talk about that report in detail. I won’t get into those details here, because it frankly isn’t helpful to this discussion since the study period stopped in 2024. This just provides the historical context that fares have been going down for quite some time. In other words, while this consolidated industry structure has been in the works for a couple decades, the airlines really didn’t significantly flex their pricing muscles until recently.
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There’s no question that consolidation made this possible, and sometimes in ways you might not imagine. For example, airline pricing teams are better at their jobs simply because there are fewer of them out there. The ones that remain tend to be much better at the job at hand. The reason this is so important for gaining pricing power is that one airline has historically been able to tank a fare initiative pretty easily, even something as simple as a small, across-the-board fare increase. Today, we aren’t seeing that.
Let’s get back to Delta’s results — I can’t do this with United yet since the 10-Q wasn’t out at the time of publication. Strip out things like loyalty revenues (which always seems to go up these days) and look at just Delta’s Q2 ticket revenue, and we see it increased 12.5 percent year-over-year. The reality is that fares went up much more than that, because a decent chunk of Q2 bookings happened before the recent run-up. But even 12.5 percent is a remarkable increase considering that capacity was flat.
This doesn’t look like a temporary blip, even though we know everything in this industry is somewhat temporary. Just look at Delta which reaffirmed its earnings guidance for the full year and United which improved it. They won’t be the only ones. It’s easy to say this is all due to that growing pot of credit card money or refinery earnings or something else, and yes, those all help. But the reality is that none of this happens without the industry’s main players all realizing that there is room for higher fares. Even if that weren’t the case, it has become easier for airlines to insulate themselves from low-cost airline fare actions, something that has always been a problem.
Pricing is far more complex than it was in the past, so there are more levers to pull. If Frontier decided it wanted a massive sale since its results are not great, the other airlines could match with Basic Economy fares only and not see their entire fare structure collapse. The ability to better segment means that fare actions can be compartmentalized.
The airlines love segmentation so much that it continues to spread. Delta is now introducing Basic Business — or as I like to call it, Delta None — which will undoubtedly keep the same pricing business class has today, simply creating an upsell for those who want a seat assignment in advance along with other goodies. It’s a straight-up fare increase that others likely can’t torpedo. (United has already gone down this path anyway.)
All this being said, fare increases don’t work in a vacuum. Capacity levels are very important, and the industry has seen capacity decline dramatically very recently. Spirit finally went away in Q2 after being unsustainable as a business for a couple of years. This takes away one more desperate management team and further consolidates the industry into something more rational.
This doesn’t mean that fares will only go up from now on. There will be a recession. There will be downturns. Maybe there will even be a well-funded startup, though that doesn’t seem very likely today. We don’t know when, but when this happens, fares will fall. But instead of plunging, airlines will better manage their capacity and keep pricing at a higher level.
This is exactly the kind of thing former American CEO Doug Parker meant when he said the industry wouldn’t lose money again. It was a tone-deaf statement that didn’t land with employees, but it also didn’t prove to be strictly true. Of course, he wasn’t thinking about a global pandemic when he said it; he was talking about normal economic cycles. And he was right. The thing is, the big airlines hadn’t really been willing to test it out until this year once it was pretty clear they had largely vanquished the low-cost carrier threat.
Admittedly, we haven’t seen this tested in any significant way since the pandemic ended. Only time will tell if this is right or not, but the fact that airlines are pushing fares higher and not seeing much blowback means they will be emboldened to keep trying to push the envelope. Now the only real question is whether the government will eventually decide this is and antitrust issue that it needs to be revisit.
