AeroplanCarriers no longer care “whether they sell a seat with dollars or miles,” said Jay Sorensen, IdeaWorks president. “Historically it was negative from a revenue standpoint if they sold a seat with miles in general. Now airlines are recognizing that these loyalty programs are tremendously valuable.” U.S. Airlines Report Sky-High Profit from Frequent Flyer Programs
https://skift.com/2018/08/13/u-s-airlines-report-sky-high-profit-from-frequent-flyer-programs/ Joe DeNardi is a Managing Director at Stifel & Associates and he closely follows US airlines and their loyalty programs. (He doesn’t cover the Canadian industry.) He has been encouraging US airlines to reveal more detail about their loyalty programs in order to properly value the airlines.
The following are excerpts from a Bloomberg article
Airlines Make More Money Selling Miles Than Seats (Mar 2017)
Does your wallet contain an airline-branded credit card? If so, your daily Starbucks visits, iTunes selections, and dining habits serve a critical role in keeping the U.S. airline industry fat and happy.
For carriers such as American Airlines and Delta, these programs are a cash cow, a golden goose, or any other fiscal livestock you care to conjure. Each mile fetches an airline anywhere from 1.5 cents to 2.5 cents, and the big banks amass those miles by the billions, doling them out to cardholders each month. For the banks, people who pay annual fees for those cards to accumulate miles are the closest thing to a sure bet.
The airline-miles business, formally known as loyalty programs, has become a high-margin enterprise that’s grown in size and value amid airline consolidation, with carriers keen to expand credit-card rolls and see loyalty members spend more.
Investors have failed to appreciate how crucial these programs are to airline profitability amid the stability consolidation brought, said Joseph DeNardi, a senior airline analyst with Stifel Financial Corp. in Baltimore. Since August, he’s issued a steady stream of client notes arguing that the market has undervalued the five largest airlines. DeNardi has repeatedly explained that investors have little insight into the billions of dollars large banks pay for these affiliations.
In many ways, the Big Three U.S. airlines have organized themselves into two distinct businesses. There’s the traditional activity—the one with jets—which involves pricing seats for as much as possible, collecting a bag fee, and selling some food and drinks while keeping a close eye on costs. The other business is the sale of miles—mostly to the big banks, but also to companies that range from car rental firms to hotels to magazine peddlers. The latter has expanded so much that it accounts for more than half of all profits for some airlines, including American Airlines Group Inc., the world’s largest.
“Airlines are earning upwards of 50 percent of [income] from selling miles to a credit card company, which we believe is a great business to be in,” DeNardi wrote on March 20.
Beyond the cash, carriers reap something else from the cards: These deals remain lucrative
in both good times and bad, as they are immune to economic cycles. That’s because of the addictive nature of miles, a dubious commodity that tens of millions of Americans, particularly those who fly for their jobs, will probably never quit. “In a recession, that [bank] business will go down, but it should provide a very high cushion to the airline,” DeNardi said in an interview. “That’s the real benefit here: It speaks to downside protection for the industry better than anything else.”
The credit-card revenues are tied to spending that’s separate from the “airline economy,” American Chief Executive Officer Doug Parker told DeNardi in January, on the company’s most recent earnings call. “So, I think you’re right to suggest that investors should do their best to look through and understand the level of those cash flows and the certainty of them.”
“We do agree it’s a really important part of our business, and we share your view that it is perhaps under-appreciated by investors,” Andrew Levy, United’s finance chief, told DeNardi on a January earnings call. Still, the airline isn’t ready to disclose its Mileage Plus numbers.
Cash pouring in from the big banks isn’t 100 percent profit—airlines are still on the hook for seats obtained with those miles, as well as merchandise offered in their catalogs. The loyalty programs’ outstanding mileage balances also count as a liability under accounting rules, giving airlines a powerful incentive to prod you to use them.
But redemption expense is largely incidental to these bank partnerships, given the widespread between what a bank pays an airline for a mile and its future cost to the airline. At American, which has the largest program, Stifel estimates a mile’s sale price is about three times its cost at redemption. (Naturally, any miles that are canceled, expire, or are otherwise never redeemed flow to airline coffers at a 100 percent margin.) “Fundamentally, airlines are selling miles to credit card companies for much more than they will cost the airline when those miles are redeemed—and they are doing it hundreds of billions of times a year,” Stifel wrote in a February client note.
Airlines have been reluctant to reveal more details about these figures, which usually run through their “other” income lines, because the bank deals typically carry confidentiality clauses. Moreover, carriers aren’t keen to show competitors detailed information about their loyalty profits. The banks, however, probably have a good sense of what their rivals are paying, DeNardi said. “If I know that the margin on this business is 60 percent or 70 percent, with a very limited level of disclosure, then [JPMorgan Chase Bank, N.A.] and Citi and AmEx—the guys negotiating these agreements—they must know what the margin is,” he said. The banks are making out pretty well in these partnerships, too.
VALUING THE CREDIT CARD BUSINESS WITHIN THE AIRLINE ‘Loyalty programs are so valuable that private equity firms tend to value them at 15 times EBITDA as stand-alone companies.’ Globe and Mail, Why Air Canada is abandoning Aeroplan (2017).
In 2016, DeNardi estimated the loyalty program of the three US legacy carrier generated EBITs between 68% of 74% on loyalty revenue, and Free Cash Flow between 40% and 43%. He estimated Southwest generated a 77% EBIT and 45% FCF on its loyalty revenue. His estimates were based on ‘off-the-record’ conversations with airline executives.
From an WSJ article in Aug 2018 (Airlines Cash in on Loyalty Credit Cards), airlines’ share of total revenue in 2
ndQ 2018 was Southwest at 15.3%, American at 11.8%, United at 9.3% and Delta at 8.8%. The article stated that executives at these airlines expect to make more in coming years.
In my Dec 3
rd post RE: Tremendous Alpha Ahead for AC (OTB’s post) I commented that Air Canada was at a huge disadvantage having outsourced its loyalty program years ago and not benefiting from any contractual improvements since then between Aimia and its financial partners. According to one analyst at Industrial Alliance Securities, ‘Aimia paid Air Canada $700 million in 2015, while Air Canada, which buys miles to give its frequent flyers under Aeroplan, paid Aimia $245 million the same year’ (Bloomberg).
Here are last year’s numbers published in
The 2019 CarTrawler Yearbook of Ancillary Revenue.
2018 Key Frequent Flyer Revenue Disclosures in
US Dollars FFPR PNP: Frequent Flyer Program Revenue per Network Passenger
Airline Program Name FFPR PNP Qantas Grp Frequent Flyer $37.51
American AAdvantage $27.34
United MileagePlus $26.71
Southwest Rapid Rewards $25.26
Delta SkyMiles $21.35
Air Canada Aeroplan $11.22
The author of this publication cautions that approximately 90% of this revenue is generated by the relationship with bank partners, and the other 10% by selling miles directly to members, or points sold to hotels, car rental companies, or retail partners.
Under the new arrangement, Air Canada earns a few cents on every dollar spent using an Aeroplan credit card. There is also the premium card annual fee. Banks also typically pay incentives based on the number of new cardholders who sign up. As ‘OnTheBalance’ has commented in previous posts, ‘Air Canada is making money on millions of card holders spending billions of dollars each year on their Aeroplan card.’
One US legacy carrier’s credit card arrangement earned the airline 3.7 cents on every dollar of credit card spend. This would comprise a percentage of each dollar spent, annual card fees and likely incentives based on new memberships. Its annual co-brand credit card spend was $90B USD in 2018. Given that Air Canada would have benchmarked the US carriers, and other global carriers such as Qantas, it’s reasonable to assume that the Airline is earning at least this.
And as mentioned in
Lost In Translation, Air Canada’s goal is to grow credit card subscriptions from 5 million to 7 million between 2019 and 2021. But make no mistake, Air Canada executives are aiming for what Qantas has achieved in credit card memberships. Recall Qantas has captured 50% of the Australian market (12.7 million members) representing 35% of all credit card transactions.
From Slide 123, Investor Day, February 28, 2019 (Speeches and Presentations):
Air Canada’s annual repeat customers is 28% vs 16% average for the US carriers.
Air Canada home country market share is
significantly above its US counterparts:
Air Canada 47%
American Airlines 22%
Delta 21%
United 16%
This market share will continue to grow. Slide 123 also states the
opportunity for Air Canada is to increase credit card penetration for elite members (currently at 38%, US carriers average is approx. 50%) and loyalty penetration of airline flyers (currently at 35%, US carriers average is approx. 52%).
Besides the ‘moat’ effect that an industry leading loyalty program brings to the Airline, the financial benefits are leading to increasingly durable earnings and higher free cash flows, as well as smoothing out seasonal flying variations.
Air Canada’s growing and enhanced loyalty program, together with its unique geographic advantage, extensive global network and premium products leveraging 6
th freedom flying, represents yet another way the Airline is differentiating itself from its competitors.
The more a company competes on uniqueness the less susceptible it is to imitation, and advantages can be sustained over long periods of time. - Michael Porter (Harvard Professor, Strategist)