US Airlines Analysis: Spirit Airlines, JetBlue Pressured by Domestic Overcapacity, Rising Labor Costs; Hawaiian Airlines Large Order Book Raises Liquidity Concerns

Relevant Documents:
Link to American Airlines on Aggredium
Link to Delta Airlines on Aggredium
Link to United Airlines on Aggredium
Link to Airline Data Template on Reorg

Cash flows have come under pressure across the airline industry as declining revenues coupled with rising labor costs have squeezed margins at a time when large order books will be pushing up capital spending in the coming years, potentially worsening overcapacity. A shift in leisure travel toward long-haul international routes has led to a surplus of aircraft in domestic markets and Latin American routes, driving heighted competition that has pushed down pricing, with smaller, regional airlines, such as Spirit Airlines and JetBlue, particularly exposed. Third-quarter results from the major airlines also reflected challenges with weather, air traffic control shortages and Pratt & Whitney engine issues, as well as ongoing cost escalation associated with new pilot contracts and other labor pressures.

Despite carrying large cash and securities balances, the potential for elevated cash burn in the coming quarter and years has spawned concerns about the financial health of certain carriers including Hawaiian Airlines, JetBlue and Spirit, all of which saw sharp declines in the trading prices of their debt and equity instruments during October. Spirit and JetBlue are disproportionately exposed to the domestic market, as well as to the Pratt & Whitney engines, resulting in more severe margin compressions than some of their peers. Hawaiian Airlines, while experiencing strength in its international routes to and from regions in the Pacific, was hit by sharply weaker demand domestically as a result of the wildfires in August.

Hawaiian Airlines will need to fund almost $2 billion of firm aircraft orders in the next four years while also addressing its $1.2 billion of secured debt due in 2026. This may be challenging, given that its third-quarter EBITDA was negative and the company burned more than $150 million of cash in the quarter.

JetBlue and Spirit could also have trouble financing their order books, particularly if their merger is blocked or if they are unable to achieve the anticipated $600 million to $700 million in synergies. The market has become increasingly skeptical that the merger will be approved; this is reflected by Spirit Airlines shares trading at less than one-third of the prepayment-adjusted merger all-cash takeout price. JetBlue has about $1 billion of flight equipment commitments in the fourth-quarter of 2023 alone, and about $2 billion per year in 2024 and 2025, while Spirit has commitments for over $1 billion per year in 2025 through 2027. Spirit faces a $1.1 billion maturity in 2025, which may be difficult to refinance when third-quarter cash burn exceeded $250 million.

Industry Revenue and Geographic Split

American Airlines again underperformed United and Delta on revenue growth, both sequentially and year over year, driven by the company’s geographic exposure, domestic and Latin America, and a reduction in price, as measured by revenue per passenger mile. Revenue breakdown, comparing each company and aggregating to a “Big Three,” is shown below. Growth for the third quarter is shown relative to the third quarters in 2019 and 2022 and the second quarter of 2023.

Smaller U.S. based airlines - Spirit Airlines, JetBlue and Hawaiian Airlines - all underperformed when comparing year-over-year revenue, and Spirit and JetBlue also reported sharp sequential revenue declines.

Operating data and financials used in this article for each of the companies are pulled from Fundamentals by Reorg. To request a trial of Fundamentals by Reorg, please email sales@reorg.com. Subscribers of Fundamentals can use the Excel download along with the Excel plugin that enables automatic updates of data. A link to the spreadsheet template can be found HERE.

Focusing on just the largest regions - domestic, Atlantic, Latin America and Pacific - airline revenue growth of 0.1% at American, 10.8% at Delta, 12.4% at United, negative 6.3% at Spirit Airlines and negative 1.8% at Hawaiian Airlines can be partially explained by geographic mix. Of international activity in the aggregate, revenue from Latin America, which is American’s and Spirit’s largest international market, experienced the slowest growth, as shown below. United, which has greater international exposure than American and Delta, particularly in Pacific regions, experienced the strongest international growth. Hawaiian Airlines experienced strong growth in flights to and from the Pacific, but because of sharp domestic declines, likely driven by the wildfires, it saw overall revenue declines year over year.

JetBlue does not break out its revenue by geography, so it is not shown in the table below. However, on the company’s third-quarter call, management commented on recent weakness, pointing to overcapacity, beginning with Florida, which is the U.S. hub for many Latin America flights. It stated, “Latin continues to be pretty resilient … some other places, like Florida has a lot of industry capacity right now. Demand is healthy. We have no concerns there, but it’s a bit, I’d say, temporarily pressured by industry capacity, which should, I’d say, absorb over time.”

The weakness in flights to and from Latin America is nothing new. Spirit Airlines had expected weakness in the domestic and Latin America markets heading into the third quarter, commenting that it had “expect[ed] the demand trends in the domestic U.S., Latin America, and the Caribbean to continue to be weaker than normal throughout the third quarter as a result of the carry-forward of demand shifting to long-haul international and very difficult operations throughout the peak due to weather and [air traffic control staffing issues].”

In terms of domestic weakness, American Airlines claims that it’s focused on short-haul flights and said that long-haul, such as New York to the West Coast, has been resilient. “There’s way fewer people originating New York who are looking to take day trips to Boston or Chicago or Detroit, but that New York City customer is much more interested in flying long-haul - internationally long-haul to the West Coast markets and Florida.”

Internationally, similar to second-quarter results, growth was again strong in trans-Atlantic and trans-Pacific flights. However, for Hawaiian Airlines, 73% growth in its flights to and from Pacific locations was not enough to offset the decline in domestic growth year over year.

Capacity

Capacity, as measured by available seat miles, appears set to grow, including domestic. Although American made the comments above about weakness in short-haul demand, the company says it plans to increase regional activity, stating, “It’s bringing back our regional jet network, which creates a lot of revenue benefits for us and a lot of unique markets for our customers,” adding, “As an example, even today, we could be flying 5% more with the aircraft we already have in our fleet. We’re eager to restore regional service to the underserved smaller markets that are still feeling the effects of the pandemic.”

JetBlue, on the other hand, plans to reduce capacity. The company said, “Excess industry capacity during off peak periods is driving domestic yield pressure,” and as a result, the company expects to cut capacity by 5% sequentially. Year-over-year capacity guidance, although still higher than a year ago, represents a slowdown as compared with the rest of 2023. However, the company is also anticipating accelerating revenue declines in the fourth quarter.

In 2023, JetBlue took delivery of 17 aircraft and returned seven. 2024 net deliveries are expected to fall to four.

However, growth appears to be on the international side highlighting that JetBlue “recently announced the closure of two Blue Cities and other capacity adjustments. As we look ahead, our capacity growth is expected to moderate in the fourth quarter and will be driven primarily by international markets, which have demonstrated yield resiliency this year.”

Overall, capacity grew in the third quarter at a faster rate than demand, resulting in lower load factors (passenger miles divided by available seat miles) as compared with the year-earlier quarter. Again, operators focused more on domestic and Latin America experienced greater declines in load factors.

Revenue and Cost Growth

Not surprisingly, these same airlines with significant domestic and Latin America exposure experienced the sharpest pricing declines, as measured by revenue per passenger mile (revenue yield) and revenue per available seat mile. As noted above, JetBlue blamed domestic capacity increases for the drop in pricing. American, Spirit, JetBlue and Hawaiian all experienced sharp drops in both revenue yield and on a per-seat-mile basis, with Spirit and JetBlue experiencing the sharpest drop, 15.5% and 13.9% year over year, respectively.

Spirit Airlines, which did not hold a conference call for its third-quarter results, said on its second-quarter call that the company was at first disciplined, not chasing price. However, toward the end of the second quarter and into the third quarter, the company accepted the lower pricing. CEO Ted Christie said, “We believe we missed out on some passenger volume in June and July, holding out for higher yields that did not materialize, and we have revised our approach for the fall.” Matthew Klein, Spirit’s chief commercial officer, added, “As we talk about June and think about June, but then also into the third - end of June and then into the third quarter, we took a position that we had been seeing really for the last 15, 16, 17 months of the demand will be there and will come in and the yields will be impressive. And that just stopped relatively quickly.”

For many of the airlines, Spirit, JetBlue and Hawaiian in particular, costs are adding to cash flow pressure. Although companies got relief from lower fuel prices, costs excluding fuel were higher year over year.

Higher labor costs were cited by companies as reasons for the rise in non-fuel costs. JetBlue blamed air traffic control issues resulting in higher labor premiums, hoteling and disruption-related costs. In addition, the company said it added additional pilot reserves in the quarter. In the fourth quarter, the company expects an acceleration of the year-over-year growth in ex-fuel costs per available seat miles to a range of 8.5% to 10.5%, driven by additional compensation step-up tied to a new pilot agreement.

Describing the new pilot deal reached in August, American Airlines said, “It’s a deal that, while it certainly comes with increased compensation and benefits and expense, but it also is something that puts us in a position where we can train our pilots in a much more efficient manner and quickly” (emphasis added).

Cost pressure could continue. American Airlines added:

Fuel prices, on the other hand, helped results in the third quarter. Although fuel costs bounced somewhat sequentially, prices still remain below year-ago levels.

Historical Leverage and Cash Flow

Although the EBITDA and free cash flow of the Big Three airlines - American, Delta and United - have returned or now exceed prepandemic levels, the smaller airlines - JetBlue, Spirit Airlines and Hawaiian Airlines - all trail 2019 levels by a significant amount.


JetBlue, Spirit Airlines and Hawaiian Airlines all generated negative FCF in the LTM period ended Sept. 30. Spirit Airlines’ and Hawaiian Airlines’ operating cash flow was negative in the LTM period, and Hawaiian Airlines’ EBITDA was negative.

American has been able to generate significant cash flow by keeping capital spending lower, at approximately $2.5 billion over the last two years, compared with $4.3 billion in 2019. American estimates that it will increase capital spending from 2022 and 2023 levels but should still remain moderate, compared with pre-Covid levels. American’s capital expenditure estimates are below:

American, Delta and United have devoted a significant amount of cash to paying down debt, as shown in the table above.

Hawaiian Airlines

Beyond the competition and overcapacity afflicting all market participants, Hawaiian has faced additional challenges from the August wildfires in Maui as well as constrained fleet availability because of the required Pratt & Whitney powder metal inspections.

The August wildfires slowed domestic-travel new bookings within the islands, but management noted that the overall economic impact to Hawaiian Airlines was limited to $25 million in lost revenue, as some business shifted to other islands. CEO Peter Ingram also shared on the company’s third-quarter call that load factors were already “improving” in October.

The company is also facing challenges surrounding the availability of its A321 fleet on account of the powder metal inspections required for the A321’s Pratt & Whitney engines. Inadequate fleet supply drove elevated cancellations early in the third quarter, and Hawaiian has been forced to adjust its schedule to manage up to four out-of-service aircraft through the fourth quarter and into the beginning of next year.

Several engines are expected to return from maintenance next year, ameliorating some of these challenges. Hawaiian disclosed that it has “reached terms” with Pratt & Whitney regarding “short-term compensation for their failure to provide required engine spares over the course of the past several months,” but this interim agreement expires in the fourth quarter, requiring further negotiations on compensation and engine availability. The compensation is in the form of maintenance credits, which should help pull-down maintenance, materials and repairs payments as those credits are used.

The broader industry revenue and cost pressures coupled with the wildfire and engine challenges resulted in a challenging third quarter for Hawaiian, with adjusted EBITDA falling to negative $11.7 million, down almost $60 million year over year, which resulted in a free cash burn of $153.4 million in the quarter.

As depicted below, operating revenue per available seat miles, or RASM, fell almost 6% year over year to 14.08 cents, while operating cost per available seat miles, or CASM, and CASM excluding fuel and nonrecurring items both rose 9% compared with the prior-year period to 15.14 cents and 11.27 cents respectively.

Costs are also elevated, as Hawaiian is carrying about 25% more pilots on its payroll than in 2019 for a similar amount of capacity in order to prepare for the 2024 deliveries of the Boeing 787 and A330 freighters. Other rate increases, primarily from new pilot contracts have also been driving up CASM.

Despite these external challenges, the company’s performance has been bolstered by strong international performance, with robust bookings from the U.S. mainland to Hawaii as well as from Japan. While Japan-to-Hawaii revenue could come under pressure from an increase in supply in the coming quarter because of expiring “use it or lose it” slot and route requirements, the company said it is “encouraged” by the “continued recovery in Japan point-of-sale demand.”

To meet the expected strong international demand, Hawaiian Airlines has contracted a firm order for 12 Boeing 787s scheduled for delivery between early next year and 2027. The airline is also diversifying its revenue streams through the initiation of freighter revenue flights with Amazon, a contractual relationship that envisions growing to a 10-aircraft fleet in the coming months. Earnings contributions from these operations are “not yet material,” it said.

Despite liquidity in excess of $1 billion as of Sept. 30, most of which was in the form of short-term investments, this order book will necessitate almost $2 billion in capital commitments through 2027.

The company said that it expects that at least three Boeing 787s will be in service by the end of 2024, with a fourth one coming late in the year. This is driving capex up from $231 million in the LTM period to the disclosed $600 million in capital commitments for 2024.

Although much of this will be debt financed, when coupled with more than $250 million of cash burn during the past 12 months - more than $150 million of which was in the third quarter of 2023 - the company could quickly become cash-strapped. The company said on its third-quarter earnings call that approximately $560 million aircraft value remains unencumbered and that the Boeing 787 is a “very financeable airplane.”

The challenges reflected in the third-quarter results are expected to continue into the fourth quarter, with the company guiding fourth-quarter RASM down 10% to 13%, while CASM is expected to rise 2.0% to 4.1%. If Hawaiian is unable to reverse this margin contraction, the company could quickly erode its liquidity of $1.15 billion.

Although net debt is only $536 million, further debt financing is expected to encumber new deliveries as well as potentially existing unpledged aircraft. Hawaiian Holdings’ $1.2 billion loyalty program financing due in 2026 recently suffered a precipitous drop in trading prices, falling from the low 90s at the start of September to the low 70s now.

 

JetBlue

Since disrupting the proposed Spirit-Frontier merger with a superior proposal in mid-2022, JetBlue has been negatively affected relative to other major airlines by its outsize exposure to U.S. domestic air travel. As market concerns regarding regulatory approval for the JetBlue and Spirit combination have intensified recently, with Spirit Airlines now trading at a third of the merger agreement take-out price, JetBlue’s stand-alone financial health has come into focus.

Although many of the recent challenges have been attributable to industrywide disruptions, with air-traffic-control shortages and weather impacts, JetBlue’s heavier reliance on discretionary domestic leisure travel at a time when the Big Four airlines - American, United, Delta and Southwest - are increasingly directing their discounting and excess capacity to this segment also poses challenges

The potential blocking of the Spirit merger is not the only regulatory headwind JetBlue has been forced to navigate. The company is still progressing through the wind-down of its Northeast Alliance (NEA) with American Airlines, which had helped support pricing in the Northeast markets. Given lagging performance in the New York market, JetBlue is meaningfully reducing its footprint at LaGuardia Airport and taking advantage of the Federal Aviation Administration slot waiver extension to reallocate its capacity to stronger markets. The New York City impact of the NEA termination is expected to be about a two-point headwind in the fourth quarter, improving in 2024 as capacity is reallocated out of the region.

JetBlue is also absorbing higher costs associated with a two-year pilot-contract extension approved in January 2023, which carried a $95 million impact. Pratt & Whitney engine issues have also affected the airline, and it expects six aircraft grounded at the end of 2023, with the out-of-service number increasing through 2024 to end the year in the high single digits to low double digits.

While “discussions around compensation are ongoing,” the engine inspections will continue to affect capacity and cost in 2024, the company said. These factors, coupled with operational challenges, have undermined the company’s cost initiatives, pushing up CASM excluding fuel to 10.26 cents in the third quarter, up almost 6% year over year.

With a step-up in JetBlue’s pilots’ contracts next August, required maintenance on its aging fleet, and continued industrywide pressures on labor, management expects cost headwinds to persist next year.

The airline hopes to offset these with a structural cost program that is targeting $70 million in cost reductions in 2023 and $150 million to $200 million in run-rate savings through 2024. These initiatives, alongside a fleet modernization program on track to achieve $75 million of maintenance cost avoidance through 2024, are intended to keep costs in check, particularly with rising fuel prices the company has only partially hedged. The modernization is being achieved through the substitution of new A220 aircraft, which “provides a 20% unit cost benefit” compared with the E190 aircraft the company is retiring.

Similar to Hawaiian airlines, this fleet modernization necessitates large capital commitments, as JetBlue’s had more than $7 billion of flight equipment purchase obligations as of Sept. 30, which includes firm aircraft orders for 56 Airbus A321neo planes and 81 Airbus A220 aircraft through 2027. Although management expects its “healthy unencumbered [asset] base” will “support a healthy liquidity level as [JetBlue] navigate[s] through 2024,” with almost $2.2 billion of flight equipment commitments in 2024 and third-quarter EBITDA dropping precipitously from $306 million in the prior-year period to $41 million in the recent third quarter, it appears likely that leverage will tick up from the approximately 5.4x gross leverage and 3.3x net leverage as of Sept. 30.

On the third-quarter earnings call, management shared that $1 billion of liquidity has been secured, including $600 million that the company has already received, and after those financings, it is expected that about 50 aircraft will remain unencumbered. Management also pointed to the loyalty program pledged to the bridge facility that will be released once the bridge is taken out as well as other engines, slots, gates and routes that could be pledged in the future to raise additional liquidity.

This could beget a meaningful step-up in leverage, particularly with third-quarter 2023 FCF approaching negative $500 million, similar to the cash burn for full-year 2022.

These concerns have been reflected in equity and debt pricing, as JetBlue’s 0.5% convertible notes suffered a sharp drop in price in October to the low 60s from the high 70s, before settling in the mid-60s recently.

Apprehension about JetBlue’s stand-alone competitiveness if the Spirit merger is blocked, coupled with concerns regarding Spirit’s recent performance, has likely driven the trade down.

Spirit

Spirit’s financial predicament is arguably considerably worse than either JetBlue or Hawaiian given its disproportionate exposure to some of the headwinds facing other industry participants. This precipitated a sharp decline in third-quarter earnings, with Reorg-estimated third-quarter adjusted EBITDA of negative $93 million, down considerably from positive $92 million a year earlier and from positive $131 million the prior quarter, which was up 113% year over year.

The company declined to host a third-quarter earnings call, and its 8% senior secured notes due in 2025 plummeted on the back of third-quarter earnings to about 60% from 93%. The stock is currently trading below $9 per share, less than a third of the all-cash deal consideration of $33.50 (less prepayments and ticking fees already received by shareholders).

Similar to JetBlue, Spirit’s exposure to domestic and near-field international demand as the industry witnesses a “dramatic demand shift away from these regions towards long-haul international,” and the weather and air traffic controller disruptions plague the market have pressured both fares and costs. The company’s total revenue per available seat mile, or TRASM, and yields both fell about 2 cents, while adjusted CASM excluding fuel rose 0.34 cents in the third-quarter. Although an expanded fleet drove up capacity, and RPMs and ASMs rose more than 10% year over year, load factor declined to 81.4%, from 83.3% in the prior-year period.

Like its competitors, Spirit was forced to take aircraft out of service this year to inspect the Pratt & Whitney engine control issues, but as the “largest operator of geared turbofan, or GTF-powered new engine options, or NEOs in the United States, with the highest number of engines produced during the 2015 to 2021 period,” Spirit’s operations will be disproportionately affected by these inspections. While Spirit has noted that “RTX has promised to make the airlines affected by the new NEO engine issue whole,” the ability to recoup all financial impacts precipitated by these developments as well as timing of the receipt of such compensation are uncertain.

Near-term clarity on a resolution to these problems is of heightened importance given Spirit’s $1.1 billion of senior secured 8% notes maturing in 2026. This security has traded down significantly over the past couple weeks to about 60% now from close to par in mid-October.

Despite over $1.3 billion of liquidity, almost $1 billion of which is cash and cash equivalents, Spirit also has a large order book, with purchase commitments for aircraft and engines of $456 million in 2024 and over $1 billion per year in 2025, 2026 and 2027 with almost $2 billion in 2028 and beyond. Spirit’s firm aircraft orders consisted of 101 A320 family aircraft with Airbus as of Sept 30, with three to be delivered in the fourth quarter and seven scheduled for 2024 delivery. This is a meaningful step-up from the average of approximately $550 million spent from 2016 to 2022 on capital expenditures and delivery deposits on flight equipment, though this fell to an average below $300 million in 2021, 2022 and the last twelve month period.

With only $170.5 million of Reorg calculated LTM adjusted EBITDA and net leverage already in excess of 13 times, it is challenging to envision a sustainable funding structure to allow this expansion, and even more difficult to conceptualize how the company could address the large 2025 maturities. It appears highly likely that absent a combination with JetBlue, Spirit would be forced to restructure its debt and potentially liquidate its operations given the challenging industry dynamics.

JetBlue-Spirit Merger

With Spirit’s stock trading below 30% of its pre-payment adjusted merger take-out price, it is clear substantial doubt exists as to the regulatory pathway for merger approval. Following the strike-down of the NEA in May, it seems likely the Massachusetts district court would also recognize anti-competitive concerns regarding the Spirit and JetBlue combination, particularly with prior Spirit statements alleging “lasting negative impacts on consumers” in the event of a JetBlue acquisition. While considerable break fees may have allowed JetBlue to succeed in the protracted bidding war with Frontier to acquire Spirit in an all-cash offer for $33.50 per share. While market skepticism existed since the offer was made in April 2022, as evidenced by discounts approaching 40% in May 2022, the massive drop in share price following third-quarter earnings indicates the standalone health concerns are the preponderance of the worries.

The JetBlue and Spirit combination was premised on $600 million to $700 million in net annual synergies, driven by “expended customer offerings resulting from the greater breadth and depth of the network.” Either company’s ability to effectively compete against the big-four players in the space absent a combination that enhances the merged entities’ relevance in legacy hubs is uncertain if the environment with persistent excess capacity continues, particularly with the entry of new ULCC’s driving down fares and legacy airlines reallocating capacity towards leisure routes.

The Department of Justice opposition to the merger is driven by concerns that such a combination would “conservatively cost consumers roughly $1 billion in net harm, every year.” The merger trial is ongoing in the U.S. District Court of Massachusetts, the same court that struck down the NEA, though a different judge is presiding. Opening arguments were heard on Oct. 31, and the trial is scheduled to last through Dec. 5. JetBlue said on its third-quarter earnings call that “assuming a successful outcome, [the company] remain[s] on track to close the transaction in the first half of next year.”