Analysis: US second quarter results

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Growing ancillary revenues helped US low-cost carriers book profitable second quarters despite heavy pressure on fares, but cost-cutting efforts by the majors were not enough to avoid a further round of losses.

Taking refuge in a generally lower exposure to starkly weak business demand, all three major US low-cost carriers posted profits in the second quarter despite the deep discounting that sent passenger revenues tumbling. US major carriers continue to suffer, as an unexpected pelting from the H1N1 virus only served to further deteriorate their already anaemic revenues.

Both JetBlue and AirTran reported consecutive quarterly profits while Southwest rebounded from a first quarter loss. Average fares during the quarter fell 8% and 14% at JetBlue and AirTran to $126 and $86, respectively. Southwest's fare decrease was 3.5% with average fares in the second quarter dropping to $110.

But ancillary revenues helped AirTran offset double-digit declines in passenger unit revenues and also aided JetBlue in alleviating a 6% decline in those areas. Southwest chief executive Gary Kelly boasts that while "revenue declines are certainly unpleasant, the 6% decline [posted by Southwest] on a unit basis is dramatically better than our high-fare competitors and in-line with our low-fare competitors".

The shield those low-cost carriers have from dried up business demand underlined their ability to achieve and sustain profits during the quarter.

Caribbean boost

JetBlue remains particularly enthusiastic about its Caribbean expansion strategy. Carrier chief executive officer Dave Barger acknowledges that while its primary base of visiting friends and relatives traffic is not inelastic, "it's been really strong in terms of the Caribbean markets specifically". He says VFR traffic in its Caribbean markets appears to be less price sensitive. A pull-down in some Caribbean markets by legacy carriers as part of wider cuts has created pricing traction for JetBlue in the region. "There have been some real interesting opportunities on the upper end of the fare structure," he says.

JetBlue's experience in leveraging some higher prices in the Caribbean is an anomaly overall, as Barger says sale activity for the fall has already started, adding further pressure to yields.

AirTran plans to manage those declines both through costs and its leisure passenger base that largely shops on price, says chief financial officer Arne Haak.

The carrier has one of the lowest cost bases in the industry, according to Morgan Stanley analysts William Greene, who estimates AirTran's ex-fuel CASM for the last 12 months is well below six cents, second only to niche carrier Allegiant and lower than Southwest.

AirTran chief executive officer Bob Fornaro admits he'd prefer to see fares a little higher, but also continues to stress AirTran's cost structure lends the carrier flexibility in a weak revenue environment. Haak predicts AirTran should report "a small economic profit in the third quarter".

Legacy limbo

Of course cost discipline is not lost on US legacy airlines. US Airways drove its mainline unit costs excluding fuel and special items down 2.1% in the second quarter, while United's consolidated unit costs ex-fuel were flat. American's consolidated unit costs grew 4%, while Continental posted a 3% increase its mainline unit costs. Delta's consolidated unit costs grew by 2%.

But the cost control did little to ease double-digit decreases in passenger unit revenues for US majors as American, Continental, Delta and United all posted losses for the second quarter. US Airways earned $40 million after adjusting for gains and losses that settled in the second quarter and from its fuel hedging programme.

The historically weak demand has triggered Delta to reverse predictions of profitability it made for 2009 during the first quarter. "Similar to the rest of the industry Delta is experiencing significant pressure on revenues," explains carrier chief executive Richard Anderson. "We do not expect to be profitable this year."

Sharing his view on the magnitude of plummeting revenues during the second quarter American chief executive Gerard Arpey says: "We have to go back to the third and fourth quarters of 2001 to find steeper revenue declines."

Despite Southwest's net profit of $54 million carrier chief financial officer Laura Wright declares the carrier's 9%-10% slide in unit revenue during the month of June as the worst decline the carrier has experienced since the post 9/11 period, surpassing the drops of the 1991 recession.

The H1N1 flu virus that broke out in Mexico at the end of April is attributable to some of the revenue degradation. Both legacy and low-cost carriers alike felt the jolt in demand from the outbreak's aftermath.

The largest US carrier with direct exposure to Mexico, Continental, estimates H1N1 reduced its consolidated revenues for the quarter by $50 million. Delta estimates a total $250 million revenue hit in 2009 driven by weakened demand from H1N1. Previously, Delta executives have highlighted weakened point of sales in Asia as H1N1 resurrected memories of the SARS spread earlier in the decade.

With the dire revenue performance of the second quarter now left behind most carriers are issuing careful assessments of a levelling off in the sharp declines in demand. "Commentary confirms our view that demand is bottoming, but management teams clearly cautioned [during quarterly presentations] that there were no signs of a major rebound in the near-term," says Greene of Morgan Stanley.

"We don't know when a recovery will come and there is a lot of uncertainty about the economic environment," says Continental chief operating officer Jeff Smisek. "However, from the revenue per available seat mile degradation perspective, we do think we have hit the bottom." But at the same time he issues the caveat that "we don't know how long we will bounce along the bottom. Our success is highly correlated with the return of business travel and we haven' t seen that yet."

Carriers have little visibility into the autumn when leisure demand drops and dependence on historically high-yield business traffic expands. But US Airways president Scott Kirby is encouraged by improvement in the carrier's contracted corporate revenue. He explains it trended down 30%-35% every month between January and May. But in June the decline was 28% followed by 22% decrease for most of July.

"Additionally we've seen an uptick in flown RASM in business oriented markets like the shuttle," says Kirby. "As a result of modest fare increases and modest business travel recovery, we've also seen some improvement in our booked yields."

Barclays Capital analyst Gary Chase identifies business travel as "the lynchpin for any potential recovery and nearly all the companies pointed to trends getting slightly better".

But Delta chief executive Anderson remains cautious warning not to "take the stabilisation and the bit of increase we've seen in business travel the last couple of months as a long-term trend".