baggage tail wagging the airline dog

Although I know a lot of value investors, I’ve never met one who was enthusiastic about holding domestic airline stocks.  For those who are, and I’m sure there must be some, I imagine that part of the appeal is that most times they have the field to themselves.  So the fact that information about airlines flows fairly slowly on Wall Street offsets some of the risk in this highly volatile industry.

True, I was a big holder of Southwest in the Eighties, and had large positions in Singapore Air and Cathay Pacific.  But, for me anyway, the attractions of even the Pacific ex Japan carriers have long since dimmed.

Yesterday the global airline trade group, the International Air Transport Association (IATA), issued a press release in which it increased its full-year profit forecast for the industry from the $8.9 billion forecast in September to $15.1 billion (in March, the IATA was projecting an industry-wide loss of $5.6 billion for 2010).  This follows two years of losses.

Basically, almost all the money will be made in the Pacific ($7.7 billion) and the US ($5.1 billion), with Europe barely holding its head above water.  Passenger traffic is back to normal.  Freight, recovering from its worst performance on record last year, has slowed a bit recently after a torrid first half driven by corporations rebuilding the inventories they cut so drastically in 2009.  Profits will contract next year, according to IATA, as the industry adds capacity faster than demand will grow.  In other words, back to “normal” in the airline biz.

Yesterday, the Chicago Tribune published an article on the US airline industry that caught my eye.  According the newspaper, the top 20 US airlines collected $906.4 million in passenger luggage fees during the three months ending in September.  They have taken in $2.6 billion in baggage fees and $1.7 billion in charges for reservation changes/cancellations–a total of $4.3 billion–year to date.

If we make the simple-minded (but probably very accurate) assumption that the December quarter will be just like the September one, then the US airline industry will collect $3.5 billion in baggage charges for the full year.  I think it’s reasonable to say that these revenues drop straight to the bottom line, since the airlines have to process passenger baggage whether they charge explicit fees for it or not.  So the fees themselves are pure gravy. Remember, too, that having tax loss carryforwards from two years of losses, pretax income for the airlines on an IRS basis and net income are probably just about the same.  If so, baggage fees will amount to a whopping 69% of industry profits.  Add charges for reservation changes to that and you have a number well in excess of industry profits.  (I’ve looked in vain on the Bureau of Transportation Statistics website for the data release the Tribune article refers to, so I don’t have a third quarter figure for change/cancellation fees.)

How strange!  the airlines essentially give away their transportation services for free , to get the opportunity to collect baggage and reservation change fees.

There are, or have been, other industries like this.  For example:

–At one time, the chains of furniture stores that used to operate along the side of local highways, and whose carcasses can to this day still be seen in some places, made all their money on finance charges from the sofas and easy chairs they sold.

–The last time I looked seriously at movie theaters, admittedly more than a decade ago, they made nothing from showing movies.  All the profit derived from the huge tubs of popcorn and the sodas and candy they sold at the refreshment stands.

–In its early days (no longer), Costco’s pretax profit equalled almost exactly the membership fees it charged. In effect, it sold the merchandise in its warehouses at its cost.

Back to the baggage fees.  On the one hand, I think it’s admirable that the airline industry is taking steps to try to cover its costs.  The fact that IATA expects the US airline industry profits to drop next year by about $2 billion, despite an improving economy,  says this is more a band-aid than a life-saving operation.  It could be that the IATA is just a horrible forecaster, but I suspect that’s not the case.




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