How do mergers among commercial airlines impact public airports – and their credit quality? As US Airways and American Airlines officially tie the knot in a merger that will result in the “New American,” how the combined airline organizes its route network carries implications for airports across the country. While the New American agreed to continue service to certain specified airports and maintain current service levels at its existing hubs for three years to settle the anti-trust complaint lodged by the US Department of Justice that could have stopped the merger, previous airline combinations indicate that service patterns of the New American are likely to change over time.
While the reorientation of airline networks may prove unsettling for select airports over the next few years … over the long term, Stettler believes the consolidation of the domestic airline industry will be favorable to the nation’s airports.
The US Airways/American Airlines union is the latest in a string of airline mergers, preceded by the Southwest/Air Tran merger in 2011, the United/Continental merger in 2010, and the Delta/Northwest merger in 2008. Such mergers definitely carry the potential to impact the way in which airlines use public airports, according to Peter Stettler, Director of Municipal Credit Analytics at BMO Capital Markets. “When airlines merge, we often see a reorientation of the combined airlines’ route network, with some airports gaining traffic at the expense of other hubs.”
Stettler, who has been covering the airport sector as a senior rating agency and sell side credit analyst for over 10 years, points to changes in Delta’s route network as that carrier absorbed the former Northwest Airlines as an example of how a merger affects airports. Prior to the merger, Delta operated connecting hubs at Atlanta Hartfield-Jackson International (ATL), Cincinnati – Northern Kentucky International (CVG), and Salt Lake City International (SLC) airports, while Northwest operated connecting hubs at Detroit Metropolitan Wayne County (DTW), Memphis International (MEM) and Minneapolis-St. Paul International (MSP) airports. Following the merger, Delta pulled down its hub operations at CVG, routing connecting passengers to its other hubs, largely nearby DTW, thereby gaining operational efficiencies. The decision also reflected the rising costs of operating smaller regional aircraft that were at the core of the CVG operation. From 2007 through 2012, the number of flights operated by Delta and its affiliates at CVG declined by 72%, while capacity (measured by seats) declined by 68%. More recently, Delta announced that it will be discontinuing its hub operations at MEM, again to gain efficiencies by shifting connections to its other hubs, mostly nearby ATL.
Over the next few years, the newly combined US Airways and American will be seeking to create the most efficient network out of their combined system, which includes large connecting hubs at Charlotte – Douglas International (CLT), Chicago O’Hare International (ORD), Dallas – Fort Worth International (DFW), Miami International (MIA), Philadelphia International (PHL) and Phoenix Sky Harbor International (PHX) airports, with smaller connecting facilities at John F. Kennedy International (New York) (JFK), Los Angeles International (LAX) and Washington Reagan National (DCA) airports. While it is possible that all of these airports will retain significant levels of service, market participants should closely monitor airports that are in close proximity to one another, such as PHL and JFK or DFW, PHX and LAX, for signs of any changes in the combined carriers’ network strategies.
Are busier airports more fiscally sound?
Public airport business models focus on cost recovery more so than profitability. Thus, while the loss of a connecting hub operation may have a significant effect on an airport’s financial condition due to a decline in revenues from passenger related activities, the airport is allowed to reallocate its operating costs among the airlines and preserve its financial integrity. At airports, such as CVG, that operate under what is known as the “residual” methodology or that have an “extraordinary coverage provision”, this reallocation process is established in the lease agreement between the airlines and the airport and takes place rather seamlessly. At airports that operate under the “compensatory” methodology or that set rates by ordinance, this reallocation may take place over a longer time frame with the airport needing to have sufficient reserves to manage through the interim period where revenues may not completely offset its operating expenses.
Airport ratings in the US range from the ’BBB’ category to the low ’AA’ range, with the average airport rating near ’A’ at all three agencies.
While these cost recovery provisions reduce the potential for an airport’s default on its obligations resulting from a loss in service, the weakened financial profile along with the increased costs passed onto the airlines, which are viewed as diminishing an airport’s competitive position, usually result in the rating agencies downgrading an airport’s credit rating as has been the case at CVG and MEM.
On the other hand, airports that experience a rise in the number of passengers that use the airport generally are viewed as strengthening credits, although increased passenger activity alone may not generate a rating upgrade. Increased passenger activity results in growing revenues from non-airline sources such as concessions and parking, which reduce the amount airports need to collect directly from the airlines. Furthermore, in addition to the reduced overall airport costs passed on to the carriers, the airlines benefit further on a per passenger basis as their airport costs are spread over a broader base.
Airport ratings in the US range from the ’BBB’ category to the low ’AA’ range, with the average airport rating near ’A’ at all three agencies. While the rating agencies consider passenger traffic levels when assessing credit quality, many other factors also come into play. The most prominent consideration is the underlying economy, as economic activity is the primary driver of demand for air service. Positive demographic trends, rising income and wealth levels, and the presence of major tourist attractions or major corporate headquarters are indicators of rising demand. Another factor that has gained prominence is the ability of an airport to generate revenues from non-airline sources including parking and concessions, with growing emphasis on ancillary revenues produced from activities totally unrelated to air service such as the lease of surplus land for alternative use. Furthermore, some public airports have significant cargo operations, which lessen dependence on the passenger airlines. MEM’s financial position, for example, may be affected less by the decline of Delta than another airport due to the presence of FedEx’s corporate headquarters and central air freight sortation facility, which allow the airport to spread airfield costs over a much larger base.
While the reorientation of airline networks may prove unsettling for select airports over the next few years as Southwest, United and the New American work to achieve the benefits of their mergers, over the long term Stettler believes the consolidation of the domestic airline industry will be favorable to the nation’s airports. “While competition within the domestic industry should remain robust, the airlines should be better able to match supply with demand and improve their financial standing over time,” according to Stettler. And a stronger airline industry should be better positioned to invest in, and support, the nation’s airports.