Certainty is a good thing, but US airlines have little of it going into the fourth quarter and the New Year. The cautious view suggests that slowing demand in the form of dwindling business travel has replaced the cost of fuel as the big uncertainty. But many believe the steps US airlines took to cope with the record high fuel prices of earlier this year will stand them in good stead for what is to come.

In 2008, US airlines are likely to have an $8 billion collective loss - $2.5 billion for the 10 largest carriers in the third quarter.Delta chief executive Richard Anderson says: "The high cost of fuel is being replaced by a softening economy and perhaps recession around the world."

He told the airline's employees in early November: "We're moving into an unprecedented time in all of our lives in terms of the financial crisis around the world and we just don't know yet what we're going to do in response."

Falling demand is a problem to be reckoned with. The nation's financial meltdown continues and carriers are contemplating even further cuts. As Anderson said in mid-November in announcing an Asian expansion, Delta's bias is towards going international rather than domestic, and even that is subject to revision.

From Detroit, for instance, Delta is cutting two flights, a nonstop Paris flight, which ends in mid-January, and a nonstop to Osaka, Japan, which ends in February. (SkyTeam Alliance partner Air France is expected to increase its Detroit-Paris service).

Revenue is falling everywhere. American Airlines is now projected to experience a 7% year-over-year revenue decline. The United Airlines drop is forecast at 6.3% and Delta's at 3.5%.

"Pretty much all of the economic and travel industry data-points suggest travel demand will be bad to very bad in 2009," says Kevin Crissey of UBS Securities. He adds that he sees revenues down about 5% industry-wide. But he is "optimistic that this will be the last downward revision to revenue required as only the September 11 period saw a larger revenue reduction".

Still, in early November, Continental Airlines sharply reduced its forecast for November unit revenues, a key benchmark. It now expects a 4-6% increase from a year ago in revenue per seat mile instead of the growth in the "low to mid-teens" it was predicting recently. Close-in yields are expected to come in lower than earlier anticipated as a result of the weakened economy.

Continental is alone among the majors in forecasting its own revenues, but other carriers have noted the trend. For instance, Alaska Airlines urged caution in announcing its third-quarter losses.

Brad Tilden, the group's chief financial officer, told analysts: "I think it would be appropriate to be a little cautious with how much folks extrapolate from these advanced bookings that we're looking at today."

But falling demand is an unknown, and when measured against the known, against the cuts that the carriers have imposed so far this year, many see room for optimism. Jim May, president of the Air Transport Association, says: "The good news is we were prepared." May predicts that there is "the very real chance we'll be operating in the black in 2009".

Capacity cuts

The airlines have pulled out about 10% of flights from the entire system. They parked 750 aircraft and laid off about 37,000 people. But Calyon Securities analyst Ray Neidl says: "The US airline industry had its own credit crisis last spring and adjusted for the worst this should help them get through the current crisis without bankruptcies."

The industry began to reduce capacity early this year in response to high oil prices. Capacity showed slight declines in the first three quarters, but in the fourth quarter, growth by the three principal low-fare carriers slowed to zero, resulting in an industry-wide decline of 9% in capacity.

So some executives are surprisingly upbeat. US Airways president Scott Kirby says: "Given the magnitude of the oil decline, it would take a truly unprecedented decline in demand to overcome the impact of oil."

Speaking to analysts, Kirby pointed out that each $1 decrease in the price of a barrel of oil translates into $35 million of savings a year for US Airways. And oil has declined by more than $80 a barrel since hitting a high of over $147 in July.

Kirby says industry revenue would have to decline 22% to ­offset the savings from cheaper jet fuel and capacity cuts taken by airlines in 2008 or planned for 2009. "And with the exception of 9/11, nothing like that has happened in the history of the airline industry."

FTN Midwest Securities analyst Mike Derchin expects carriers to produce a net income of $5 billion next year, equalling the 2007 level, assuming oil is at $80 a barrel, revenue per available seat mile grows 8-9%, and domestic capacity reduces by 8-9%: "Consolidation has begun, resulting in a sharp reduction in capacity and higher average fares."

Now that the fundamentals are swinging back in the airlines' favour, ancillary fees finally become a meaningful contributor to the bottom line. Back in July, when oil was over $140 a barrel, no one expected to eke out a profit by charging for checked bags or seat preferences.

Not that the numbers were meaningless: Jay Sorensen, president of consultancy IdeaWorks, estimates that US carriers may have taken in as much as $1.7 billion in ancillary revenue in 2007.

But that amount should increase significantly this year. United officials expect to generate between $700 million and $1 billion in additional ­revenue from fees in 2009.

Before its acquisition by Delta, officials at Northwest were expecting an extra $250 million to $300 million in revenue this year from the checked-bag fees they began charging in mid-year. At AirTran, Derchin estimates that a fee for a first checked bag, instituted in early December, could bring in an additional $90 million a year.

One of the more reasoned bullish forecasts comes from JP Morgan's Jamie Baker. In mid-November, Baker was forecasting a 2% decline in total industry revenues, including ancillary fees.

But he now says: "The industry has realised $25 billion in annual fuel savings. It would take a 20% decline in revenues to negate the benefit, roughly three times worse than what was witnessed in 2002." So Baker's 2009 industry operating profit forecast moves from $6.4 billion to $9.2 billion, eclipsing 1997 and 1998's $8 billion record profit.

He says the network carriers' cost disadvantage compared to low-cost players is more or less erased. "As for Southwest, its competitive advantage has narrowed as it fuel advantage reverses, the company is shrinking for the first time in history and they may seek additional liquidity."

But Crissey of UBS sounds a note of caution: "There is nothing to say fuel can't reverse course quickly and leave the airlines short on cash again.

"The balance sheets of most US airlines look as if they've just come out of a recession, rather than going into one."

Industry revenue would have to decline 22% to offset savings from cheaper jet fuel

US carriers slashed capacity earlier this year, so they already feel prepared for the battle that lies ahead in terms of falling demand for air travel

Source: Airline Business