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North America braces for fuel pain

Any reprieve from stabilising fuel prices for North America carriers was short-lived as the intensity of the global economic downturn quickly led to an erosion of demand that has yet to reach a bottom. Battered profits by those airlines in 2008 are expected to receive another beating this year as jet fuel prices creep back up to add to the continuing misery of revenue weakness.

North American carriers in the Airline Business Top 150 ranking swung to a collective net loss of $20 billion after posting profits of $6.1 billion in 2007. And at the operating level 2007's $9.5 billion profit dissolved into a $15 billion operating loss. Despite the dramatic profit decline,the carriers posted 5.8% revenue growth at $178 billion, partly driven by prudent capacity cuts, creating pricing traction, and product unbundling.

But starting in early 2009 revenue traction vanished. Domestic revenue among members of the Air Transport Association of America fell 20% during the first five months of 2009. Revenues across the Atlantic and Pacific fell 22% and 23%, respectively, and ATA chief economist John Heimlich warns the association "has not seen data yet to confirm any sort of demand stabilisation". ATA expects 14 million fewer passengers to fly on US carriers this summer. Heimlich warns: "More importantly for the airlines, that drop in volume is accompanied by a drop in average fare. Until at least one of those two indicators point north, it will be too soon to declare any meaningful change in outlook." At the same time fuel price demons are resurging, forcing upward revisions to overall 2009 fuel costs. FTN Equity Capital Markets analyst Michael Derchin says his new assumption for the second half of 2009 is approximately $85 per barrel, a marked increase from the lows of under $40 near the end of 2008.

But as oil prices rise there are faint indications of a minor levelling off in dramatic revenue drops. Morgan Stanley analyst William Greene says even his firm's most "bearish revenue indicators" suggest "a bottom is near". Still, he believes even a tempered rebound in the latter half of the year "is likely to see oil rise sooner and faster than airline revenues".

A greater risk is an anaemic rebound in 2010, warns Greene, who suggests that "could trigger a liquidity squeeze at the highest risk airlines". Two of those companies, American and United, made the top ten revenue rankings for 2008. Greene believes United sits "among the worst liquidity positions of carriers we cover". Fitch Ratings has warned further declines in unit revenue through the ­second and third quarter could "drive negative cash flow and put American's parent AMR in a difficult liquidity position moving into 2010". FTN's Derchin sees losses at those carriers and at Continental, Delta and US Airways.He recently enlarged his 2009 loss estimates for all the US majors "to reflect lower than previously expected unit revenues and higher jet fuel prices".

Not all carriers face those same challenges. FTN projects that Alaksa, AirTran and Southwest willpost profits this year. In general, analysts believe those airlines' more limited international market exposurewill soften their 2009 revenue blow. Derchin estimates a single-digit unit revenue drop for low-cost carriers, versus double-digits for network operators. "Low cost airlines are expected to pay less for jet fuel than the network carriers due to better hedging strategies and less use of high-cost international jet fuel," he says.

Even some legacy airlines have shown signs of weathering the downturn. Delta is expanding its international capacity cuts, while Green of Morgan Stanley believes Continental has a more "favourable liquidity position vis-à-vis other legacy airlines". He theorises both Continental and Delta benefit the most from other carriers'capacity cuts.

One wildcard in accelerating a rebound is a resurgence in premium travel demand, important to legacy and low-cost carriers alike. "The next budget cycle begins in the fall," notes FTN's Derchin. "Airlines are waiting anxiously to hear from top corporate accounts whether business spending curbs will begin to ease for 2010 as the economy and corporate profits begin to recover."

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