Delta, United Continental To Feel The Pinch Of Lower Baggage Revenues

Baggage fees were introduced by the airlines a few years ago as the fuel prices started to bite into profits, but it constituted a relatively lower portion of the revenues. However, this segment made up for part of airline’s losses during the 2008 financial crisis by showing considerable revenue growth during that period. In fact, baggage fee revenues witnessed a CAGR of 94% from 2007-10.

The recent decline in baggage fee as reported by Bureau of Transportation Statistics on May 17 raises doubts on the future profitability of the airlines given this lucrative revenue stream. Delta Air Lines (NYSE:DAL) retained the top spot with $864 million baggage fee in 2011, but it slid 9.3% compared to previous year. United Continental Holdings (NYSE:UAL) also witnessed a 3.7% y-o-y fall in baggage fee.

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The chart demonstrates the slowdown in baggage fee for the top five players in an industry which saw overall baggage fee declining by 1% to $3.36 billion in 2011. Though the travel demand has improved in the recent past, the above trend may be a result of the rising travel costs. Passenger fares had been successfully revised nine times during 2011 which would have forced the passengers to travel light. As the ancillary revenues were getting cannibalized by the Passenger Flights segment, it also raises questions on the degree of effectiveness of the fare hikes during this year.

Since Southwest (NYSE:LUV) and JetBlue (NYSE:JBLU) do not generate much revenues from baggage fee due to their free baggage programs, they can be considered exceptions to this case. Further, Southwest’s acquisition AirTran, which is expected to charge baggage fee until full integration in 2014, managed to report a 8% rise in baggage revenues.

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Ancillary revenues are considered to have tremendously high EBITDA margins over other divisions. As the carriers are finding it difficult to maintain profitability amidst the uncertain macroeconomic environment and capacity control programs, a fall in ancillary revenues would further dent their financial performance. The magnitude of the impact could be greater on carrier’s such as Delta for which cargo and other ancillary revenues constitute more than 50% of its Trefis price estimate.