Wednesday, September 10, 2008

Lashed to the Mast: Hospitality and Airline Industry Outlook

It should by now be plainly obvious that the travel industry will be undergoing some profound changes due to the soaring cost of fuel. The International Air Transport Association (IATA) estimates that the increase in fuel bills for the global airline industry will top $91 billion this year. With the current average price of jet fuel at an eye popping $158 per barrel, many of the world’s airlines find themselves in a full throttle race in reverse to try to shrink their way to profitability.

United Airlines is disposing of their entire 737 fleet and furloughing thousands while American Airlines is also parking nearly 100 aircraft with a commensurate level of layoffs to name but two examples. The low cost carriers are also not immune with several bankruptcies and liquidations already having taken place while many of the survivors are hanging by a thread.

IATA estimates that the current situation will likely have a greater effect on the industry than did the attacks of 9/11 with industry losses of over $6 billion possible in 2008. This downturn, while similar in scope to 2001, differs as its primary cause is an engineered lack of supply driven by fuel costs as opposed to a lack of demand due to terrorism fears.

As airlines must raise fares to cover their fuel costs, many markets that were once profitable become money losers as price sensitive customers stay home. This effect is most pronounced in leisure markets as they typically have the lowest margins and highest price sensitivity.

Honolulu, for example, is losing over 27% of its air service while other leisure destinations such as Las Vegas and Orlando are losing about 15% each. Business travel is not escaping unscathed either. IATA estimates that business travel has dropped to levels unseen since 2003.

Lehman Bros. analyst Gary Chase estimates that airline seat capacity will be reduced 11% by fourth quarter 2008 and that the industry needs to shrink by at least 15% next year to achieve profitability. Some of this pain is no doubt due to a sluggish economy, but unlike past industry downturns, consensus opinion is that the airline industry will soon be smaller than it is today.

Into this breach steps the hospitality and lodging industry. The hospitality industry, which has recently enjoyed several years of robust growth and profitability, now finds itself lashed to the mast of a listing airline industry. And like the airline industry, the hospitality industry has been on a growth spree to increase its room capacity and market share.

As of April of this year the domestic US lodging industry had over 650,000 rooms in the construction or planning pipeline for an increase of 22% over the year earlier figure. These rooms will soon be looking for customers in a weak market.

Industry consultant PKF Hospitality Research estimates that a 10% decline in the number of airline seats domestically will result in a 3.9% drop in demand for lodging compared to the 3.3% drop in 2001. That translates into about 40 million fewer rooms occupied or a loss in revenue for the industry of about $4.3 billion.

This has already been reflected in the stock prices of most major hotel chains which are off between 15% to 20% this year. The weak US dollar has been a lone bright spot for some properties which cater to overseas tourists, but occupancy rates overall have started to decline for many domestic hotels. Profits are likely to be down 20% from their 2007 levels according to industry trade journal Hotels.

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