Why cash is king for airlines like United Continental

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Cash is king

Whether a mainline carrier like United Continental (UAL), Delta Air Lines (DAL), American Airlines (AAL), or a low-cost airline like Southwest (LUV) or Allegiant, every airline must invest heavily into its assets.

Airline Industry FCF

The airline industry’s cash flow over the past ten years is summarized in the table above. The blue bars are the industry’s aggregate cash flow from operations. This is after net income and it adds back depreciation and amortization and changes in working capital. Cash flow from operations is before capital expenditures. The greatest capital investment for airlines is in aircraft. Theoretically, an industry should be able to maintain consistent operations and generate free cash flow. This is a volatile industry.

What happened?

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The industry was cash flow–negative in 2004–2006, as low returns were chewed up investing in airplanes. In 2007, the industry was cash flow–positive, as returns increased. In 2008, the industry failed to generated operating free cash flow. Adding to this capital had to be spent to keep the airlines running safely. This brought about the industry being cash flow–negative by $6.3 billion in 2008. However, with improved operations and lower capital expenditures in 2009–2012, the industry was free cash flow–positive.

Here’s the rub

Airlines have no choice in the medium term but to invest in new aircraft. It’s a capital-intensive industry. Whether reaching for fuel efficiency, lower noise pollution, or nicer cabin features, companies need to invest. They can rent and they can purchase, but the money goes out the door. The new Boeing Dreamliner is approximately $250 million each, before volume discounts. But this is a large long-range airplane. The regional airplanes are less expensive. Nonetheless, United owns 400 airplanes on the mainline leases nearly 300 for the mainline operations and supports another 600 for regional operations. The average age of the fleet is 14 years. To maintain the fleet average life, assuming an average airplane could be replaced for $40 million, United has to spend approximately $3 billion in today’s dollars to keep the fleet from aging. This is why capital expenditures are increasing now. First, the industry is generating cash, and second, the industry has to invest to remain competitive.

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