US carriers face grim outlook

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This year's Airline Business airline rankings show that North American carriers were collectively profitable last year, but the outlook going forward is grim for almost everyone, and the worst could be yet to come

US airlines have become like the television series, Survivor: drama and tension mounts amid speculation about who is first to be forced off the island - or in the case of the airlines, who is forced into bankruptcy reorganisation or even liquidation. The expectation then is that capacity could be cut, prices would rise and some semblance of normality would return. And that could become the case in a period when fuel costs have about doubled in the last year.

This year's rankings show that North American carriers in the Airline Business top 150 collectively posted an $8.1 billion net profit and an operating profit of $10.5 billion in 2007, on revenues which increased by 6.3% to $182.2 billion. Four US carriers made it into our 15 most profitable carriers list, ranked by net profits. This year, however, things look set to nosedive.

"In our opinion, the best thing that could happen to the industry is to have one or two of the major airlines fail, liquidating their seat inventory. That would enable the survivors to raise ticket prices to economic levels," says Calyon Securities airline analyst Ray Neidl.

For the shorter-term future, though, no one is ready to leave the island. Jamie Baker, the JP Morgan airline analyst, thinks that most carriers will hobble through this year, and that 2009 will be the determining period. In this, Baker counters the thinking that airlines would be more inclined to seek bankruptcy to protect significant cash hoards, a theory advanced by Julius Maldutis of Aviation Dynamics. Baker sees airlines as still possessing enough assets and credit to preserve liquidity throughout this year. However, after carriers have sold off aircraft and taken other similar steps, legacy bankruptcies and otherwise foolish mergers become "a question of when, not if", he says.

For the second quarter, analysts believe losses at the 10 largest US airlines will be in the vicinity of $750 million to $800 million, with full-year losses forecast to be in the region of $6 billion. The Air Transport Association sees the largest carriers' losses possibly reaching $13 billion. The fuel bill for this year will be at least $61 billion, up from $41 billion in 2007 and $32 billion in 2006, according to the ATA.

The sole winner among US majors is of course Southwest, with Delta Air Lines thought to stand a chance at a profit for the year. As for the rest of the majors, though, the grim outlook is grimmer, given the charges that they have already announced. At American Airlines parent AMR, a non-cash charge of $1.1 billion to $1.2 billion will cover the write down value of the Boeing MD-80 jets it is retiring as well as its smaller Embraer ERJ-135 regional jets. At United Airlines parent UAL, the second quarter charges are between $2.6 billion and $2.7 billion, while at Continental Airlines, the charges in this quarter alone are a mere $58 million. The AMR charges, which will cover almost 7,000 personnel layoffs, could push the carrier into its single worst quarter ever. The UAL accounting charges are the entire value of goodwill on its books, plus the costs of retiring its older Boeing 737 fleet.

The Big Unknown

The problem is that the worst is still ahead. The big unknown - since rising fuel is a given - is the economy and above all corporate travel trends, says William Greene of Morgan Stanley. Second quarter unit revenue trends "were weaker than expected, considering the amount of fare hikes that have occurred. We may finally be seeing premium business travel turn down, which could have very negative consequences," he explains. About half of the companies polled in Morgan Stanley's corporate travel manager survey said they would adjust downward within a single quarter once a certain downturn in the economy is apparent. "So we could be on the cusp of seeing corporate travel trends turn south," Greene says.

The ATA's chief economist, John Heimlich, is pessimistic, saying that an inflation-driven recession is possible in 2009, and that airline revenues are still $20 billion below their historical norm.

Morgan Stanley's Greene says: "A 2009 tipping point still looks highly plausible and we believe more capacity cuts are needed. But airlines have little incentive to intentionally overshoot with capacity cuts and are more likely to chase oil for a number of reasons. The network effect of the hub-and-spoke model deteriorates as capacity is cut."

But that said, airline capacity cuts have yet to reach critical mass, and this suggests that this winter will be a grim one indeed.