MARKET COMMENT
100 Years Of Flying

By David Kuo (TMFDragon)
December 17, 2003

Air travel has come a very long way since 17 December 1903 when Wilbur Wright successfully achieved powered flight. Wilbur reportedly won the right over his brother to pilot their hand-built single-seater plane on the toss of a coin.

Little did Wilbur and his younger brother know at that time that their invention would spawn an entire industry that would enable millions of people to fly not just 120 feet, as they did, but thousands of miles non-stop from one continent to another.

After Wilbur proved to world that man could really fly, it took another eleven years before America got its first scheduled airline. Sadly, the Benoist Company, which used flying boats, lasted just three months. Since then there have been hundreds of commercial airlines attempting to make a buck out of the Wright Brothers' invention. Not many have been that profitable!

Some of the more spectacular failures include the collapse of Pan American Airways in 1991. Once regarded as an icon of America and her dominance of the skies, no one at the time could ever have contemplated that Pan Am would fail - but it did.

Many reasons have been offered for Pan Am's bankruptcy and these include deregulation, which brought with it unwanted competition. Over expansion, which forced the airline into debt, has also been suggested as a reason for Pan Am's demise.

However, the harsh reality is simply that airlines are hugely expensive businesses to run. Richard Branson once joked that to become a millionaire, you start as a billionaire and buy an airline. Warren Buffet remarked that Wilbur Wright's achievement was one small step for mankind, and one huge step backwards for capitalism.

In financial jargon airlines are said to have high operational gearing, meaning most costs are fixed and so profits are very sensitive to changes in demand.  The low-cost airlines of today believe they have found an answer to high operational gearing. By driving prices lower budget airlines aim to keep their planes as full as possible. Furthermore, through intricate yield management programmes they can vary ticket prices to achieve the highest possible return on each flight.

However, it is perhaps still too early to say whether the no-frills airlines have cracked the problem of the boom-and-bust cycle of the airline industry.

It is interesting to note that successes at easyJet (LSE: EZJ) and Ryanair (LSE: RYA) have brought with them a bevy of newcomers to the no-frills sector. That is bound to be good for air traveller but perhaps less welcome for the incumbent air carriers as oversupply drives ticket prices ever lower.

That said demand for air travel in the UK is forecast to rise around 4% per year, which the main reason for the proposed expansions at Heathrow, Gatwick and Stansted airports. Investors hoping to capitalise on that rising demand should perhaps look to BAA (LSE: BAA), the owner of those airports, rather than the airlines.

The author owns shares in British Airways and BAA.