Airline 5-Year Plans
I started in Financial Planning during the heyday of consolidation. In fact, I started right after US Airways attempted a hostile takeover of Delta … yes … that actually happened! Consequently, during my career, I had the chance to build and be part of the due diligence process for many 5-Year Plans (both reviewing them and being reviewed). All those experiences reached a crescendo during the US Airways/AA merger process in an epic battle of the 5-Year Plans (a story for another day).
The 5-Year plan is one of the few places where, as an analyst, you get to see the result of the company’s strategies over a long-term horizon. A well-conceived 5-Year Plan is a thing of beauty and over the last few days, I’ve been reflecting on what the key best practices are to building a great 5-Year Plan.
Getting the right mix of complexity and accuracy
5-Year forecasts encompass multiple business lines, supported by many departments, each of which leverage a multitude of analysts. It’s easy for analysts to get bogged down trying to replicate that level of accuracy and fidelity. It’s important to keep in mind that 5-Year Plans tend to get updated pretty frequently. In that flurry of activity, you want to be able to turn forecasts quickly and easily identify and resolve issues. Complexity and accuracy are two sides of the scale and analysts must learn to strike the right balance between the two.
There is an art to creating supporting models that have defensible frameworks and assumptions and are flexible enough to change as needed. It’s hard to describe what that sweet spot looks like. But at every change to the model, I would ask myself if adding more complexity would have diminishing returns in the form of higher probability of errors, more training needs, and inflexibility to name a few.
Growing the network proportionally
A robust 5-Year Plan model must account for fleet changes and growth. Like everything in the airline, the level of operations drives the business. How is the network growing or, more importantly, how is the base network growing? For the most part, airlines use a mix of aircraft to suit different missions and different demand profiles. All of these operating profiles are aggregated by fleet in the base year. Simplistic models assume that inductions and retirements come in at the same base profile while more advanced models adjust for up-gauging and down-gauging of core markets.
I remember receiving the 5-Year Plan model for a legacy airline (that doesn’t exist anymore) and being shocked to see that it assumed that the future level of operations would be flat to the base year. No new aircraft, just leases being renewed for 5-Years while flying the same network. It’s hard to describe the feeling of seeing an airline with a static network – probably the equivalent of seeing a zombie for the first time.
Understanding profitability changes in future periods
What is happening to margins in the future? More than likely, they are going to be expanding. It would be a very depressing view of the future if margins were contracting. But more importantly, Management wouldn’t be fulfilling their fiduciary responsibility if they weren’t focused on finding ways to expand margins. A good 5-Year Plan helps identify the headwinds and tailwinds that impact margins and consequently the areas of focus for the Management team.
A key component of getting comfortable with changes in margin is understanding the relationship between fuel and revenue in future periods. For the most part, fuel is a straightforward expense to model once you have a forward curve (with maybe the exception of a hedging strategy). Revenue on the other hand is a much more complicated forecasting exercise. Regardless of how complex (or not) you make your revenue forecast - it is important to link any macro industry revenue assumptions with the forward fuel curve.
To conclude…
Creating an airline’s 5-Year Plan is a lot of fun and there are a lot of other best practices and methodologies that are worth digging into more. Please feel free to connect with me if you want to chat more.
