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Airlines: 'Supply chain is a problem' for Boeing and Airbus, analyst says

Melius Research Director of Airlines & Travel Research Conor Cunningham joins Yahoo Finance Live to discuss summer travel disruptions, airline operations and profitability, and the outlook for air travel.

Video transcript

JULIE HYMAN: Analysts at Melius Research say airline stocks typically do best in the current environment, when demand is high and capacity's constrained. But the firm initiated coverage on the industry with a neutral rating. While pent-up demand for travel's strong, it may not continue to be. Joining us to discuss is Melius Research Director of Airline and Travel Research Conor Cunningham.

Conor, it's great to see you. Before we sort of get to this formula, if you will, I do want to ask you about the current picture for what we see for travel. And just the team is probably going to laugh because they've been hearing me on an anecdotal basis talk about various relatives of mine who have had trouble traveling, cancellations. I'm sure you have some similar stories. Why can't the airlines get it together, right? I mean, this has been going on for months now, where you have this kind of situation.

CONOR CUNNINGHAM: Thank you for having me. Yeah, it's been a challenge. I was probably on this network a year ago saying the same thing. You know, the summer's-- when surging demand happens, the airlines have struggled to maintain operational integrity. You know, it starts with weather, snowballs into staffing shortages. There's a lot of construction going on.

There's just a lot of constraints on the overall infrastructure of aviation in general. So it's part of it's the airlines. Part of it's stuff that's out of their hands, from just again infrastructure being challenged and weather being what it is. I think that what the airlines are doing now-- so operations are the biggest focus for everyone.

Everyone's taken their foot off the gas in terms of adding capacity. They're trying to allow their networks to normalize. That will-- is very good for pricing longer term but will be a cost headwind in the near term.

At the same time, you just have open labor contracts across the board, makes profitability a challenge at times for some of the airlines. You know, you guys talked a fair bit about, you know, the US dollar being really strong. And that's one of the bright spots, I would say.

International demand has been off the charts. If you look at just search trends from the US to really anywhere, but mostly to Europe, they've been very, very good. You kind of see this elongated peak travel season on the international side.

So, you know, there are some struggles domestically. Weather is what it is. Staffing shortages are really challenging. There's a lot of training bottlenecks. But they've taken a step back and started to normalize what their networks need to look like to kind of be where they at from an asset perspective. And that should be better from an operations standpoint.

So hopefully, all your relatives that were delayed over the summer, that will be a thing of the past. We will see. We are going into seasonally slower periods now. So that tends to be pretty good for the [? group ?] and the operation in general.

- And Conor, one of the big problems too-- and we've gotten reports of this recently. The airline industry unable to get the parts they need to keep planes essentially flying. I mean, does this get worse before it gets better?

CONOR CUNNINGHAM: Yeah, I mean, it speaks, again, to just like the operational-- I mean the infrastructure constraints that the industry faces. Supply chain is a problem. You know, Boeing and Airbus have their own issues in terms of even new deliveries.

So again, like, when I-- I think what investors really struggle with is just we're talking about a lot of really near-term issues. And so no one feels very comfortable with what's happening near term. So it's really hard to have this longer-term view if you have no really good sense of where capacity's going to be, you know, six months from now or, like, two weeks from now.

So you know, American Airlines made a big cut towards their November schedule. You know, Delta asked for slot waiver restrictions to be extended into September. There's just a lot of issues that face the group from a capacity standpoint.

So if you can't feel comfortable with, like, actual seats and where they're going to be flying and when they're going to be flying, it's really hard to be constructive on the group 12 months from now, you know, when people start to, you know, look into 2023. Like, one thing that I've talked a lot with investors as of late is just, like, you know, I expect the industry to be 6 and 1/2% larger by 2023. That number is probably-- that's where we're at right now. But it's not going to get larger. It's probably going to shrink.

So, you know, again, like, where does Boeing and Airbus come out in terms of their own issues with deliveries? So, you know, there's just a lot of uncertainty. I know that doesn't make people feel great when they try to look at investments in the group. But, you know, you could talk about some bright spots, like the airlines that have, you know, made some of these adjustments already.

I think Delta's being really conservative with how they approach the capacity outlook. I think that Alaska Air Group is being very conservative of how they approach that look as well. Southwest, our topic, I think will be fairly constrained on the capacity side. And I think that they've faced a lot of the issues on the cost side that airlines are facing now. So some of that stuff's behind them. You know, I'm hopeful that the slower-growing carriers will do better in the next 6 to 12 months.

JULIE HYMAN: Conor, what's going to happen with pricing here? Are we going to see pricing start to moderate a little bit? If indeed we're going to start to see demand come off, isn't pricing going to have to come off too?

CONOR CUNNINGHAM: Yeah. I mean, that's the million-dollar question. Like, how does the consumer deal with inflation? That's been growing faster than wage growth. I mean, that's the biggest question that's out there. Right now-- you know, I've used this anecdote a fair bit. Like, there's a massive shift in spending to services from goods.

You sat in your house for 2 and 1/2 years. Are you going to buy another sofa? Probably not. So if you do have money and you change jobs and your wages did move up, like, you're probably spending more on going to restaurants, traveling, and so on.

So there's this natural pent-up demand dynamic that should continue into the near term. You know, if a recession hits and unemployment starts to go up, you know, like, all bets are off. Like, it's hard to really say. But from a demand perspective right now, if demand is what it is and there's enough constraints on capacity, you know, pricing's-- like, there is an argument that pricing should almost, in theory, accelerate.

One thing that I think a lot of folks are looking for is just, what does the corporate side of the equation look like? We're getting out of, you know, this peak summer travel season and moving into the fall, which is typically when corporate kind of takes over. There's still a lot of uncertainty on what that's going to look like.

You know, with tech companies, like, tech companies now are starting to push people to go back to the office. I think financial services folks are doing that as well. That should be a boon for travel on the corporate side.

But again, there's just enough uncertainty on the macro environment that it's really hard to make a good constructive call on that. And I think that that's what the airlines are struggling with. But, yeah, pricing's going to be high as long as capacity's constrained.

JULIE HYMAN: Ugh. You're killing me, Conor. And for some reason--

CONOR CUNNINGHAM: I know. I know.

JULIE HYMAN: I don't know. For something, like, I can stomach going out and having a meal that's more expensive. For some reason, the airline prices going up, especially because this service is so, so bad, just infuriates me. But I have a-- speaking of which, I have sort of a final question for you. And that has to do with the new proposal coming from the FAA to change the parameters of when you can get a refund as an airline customer, to make it more specific the definition of what a significant delay is, which would potentially increase the number of refunds that the airlines are forced to give, or on the flip side, maybe force them to not cancel as many flights.

Imagine that. I mean, what do you-- what do you think's going to happen? Do you think that rule is going to go through? And is it going to have a material effect on the airlines?

CONOR CUNNINGHAM: I don't have a great insight into, you know, the [? DC ?] on that. I mean, I would just say that it's expensive to run a bad operation. Airlines don't want to do it. Like, they know it's inconvenient for everyone. And it's not profitable either.

And so they're trying to avoid it. And so I think, you know, the July numbers are going to-- were pretty good from an operations standpoint. And so they are getting better. Again, we're going into this seasonally slower time period. So the operations should ease with that as well.

But, yeah, they're trying to avoid all this stuff. They don't want the FAA to kind of come in and start to push them around from that regard. Like, they realize that the issues are at hand.

You know, when I was going through my initiation process, like, I talked to every single airline to ask the same questions. Like, what are the gating factors towards your growth? And every single one said the operation. They want it to be better. They don't want it to be worse.

They're trying to make everyone travel with ease and get out there again and feel normal from that standpoint. It's just there are a lot of constraints. And so they are trying to size their networks now and their capacity to what they have on campus.

And so I think that that's the first right step. And now it's about while they add back, they got to make sure that they can maintain the operational integrity. If they can't, capacity rolls back. Unfortunately, I mean, you can talk about the pricing side, like, it will be a pricing good guy for the industry, a cost headwind, though.

So, like, it's not, like, they're just going to cut seats. And all of a sudden, profitability's going to be wild. It's just a delicate balance. They want-- what they-- point being is they want to run a better op. That's really what the focus is right now.