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US airline 3Q analysis: Skating along the bottom

Profitability continued to elude most US major carriers during the historically strong third quarter. Soaring fuel prices during the same three month period in 2008 that were quickly followed by the dramatic global economic downturn made any historical comparisons difficult and seemingly invalid.

Despite a continuing weakness in revenues and yields, most US carriers are timidly optimistic that the worst revenue environment in industry history is starting to show faint signs of improvement. But no executive team is willing to declare a full-blown recovery as they struggle to develop 2010 business plans amid uncertainty over a rebound in the key business travel market.

Delta, American, Continental, United and US Airways all posted losses during the third quarter, a time period that Continental chief executive Larry Kellner believes should typically produce a couple of hundred millions dollars in profits. The reprieve all carriers experienced from drastically lower fuel prices year-over-year was eclipsed by an average 18.5% revenue decline among the seven mainline US carriers.

Jeff Smisek

"There are a growing number of our corporate accounts that tell us that they're beginning to ease their most draconian travel restrictions"
Jeff Smisek, President, Continental Airlines

But both sequential improvements in revenue compared with the first half of the year, and some extremely modest success in raising fares are encouraging signs as the industry readies for the holiday travel season.

Referencing the fourth quarter outlook at Continental, the airline's president Jeff Smisek says that while the steep revenue decline it experienced earlier in the year appears to have flattened out and is bumping along the bottom, Continental management has no idea how long the drop off in high-yield traffic will last.

Smisek believes some signs indicate a modest improvement could emerge soon. "There are a growing number of our corporate accounts that tell us that they're beginning to ease their most draconian travel restrictions."

Delta president Ed Bastian is also encouraged by the drastic declines in business travel beginning to subside. He explains the improvement is more pronounced in the US domestic business segment versus international premium traffic.

Delta's overall revenues slumped 20.5% in the third quarter as volume from its corporate contracts tumbled roughly 10% year-over-year in the third quarter. The carrier's corporate revenues declined about 25%.

Bastian concedes that while Delta is not happy with that 25% drop in corporate revenue, "this compares favourably to a 40%-50% reduction we were experiencing throughout much of the first half of this year".

United posted a similar slowing of its corporate revenues for the quarter. President John Tague says those revenues are currently down by 25% compared with 40% earlier in the year. "I think the next big signal we're really looking for is how do corporate travel budgets get reset for 2010?" Tague notes. "Hopefully there's more resourcing capacity being diverted back to this expense item. If there isn't, and we don't see a continued steep improvement as we move through the next quarter or two, then we're clearly going to have to reassess."

US airways bullish

US Airways has the most bullish view among the US majors with respect to a rebound in business travel. Airline president Scott Kirby points to strength in the carrier's northeastern shuttle markets, which are largely comprised of business traffic.US Airways expects to post 5% unit revenue decline for those markets in October, representing a clear improvement over 25% decreases the carrier posted during the second quarter and a 16% tumble during the third quarter.

"Similarly, our corporate contracted revenue was down 31%, 32% and 17% in the first three quarters of the year respectively," says Kirby. "While these statistics alone don't prove that demand is recovering, or that it will stay recovered, there is strong evidence that it is indeed recovering."

John Tague (200) United Airlines 

 "I think the next big signal we're really looking for is how do corporate travel budgets get reset for 2010?"

John Tague, President, United Airlines

Management at Southwest Airlines has a decidedly contrasting view about business travel recovery, even afterposting a $16 million third quarter profit."I don't believe the worst is behind us, if for no other reason thanbecause of higher energy costs, and there's no reason to believe that business travel will return any time soon to bail us out," says itschief executive officer Gary Kelly.

Kelly says while fourth quarter bookings are quite good, they are "no doubt at lower fares than a year ago". During the third quarter Southwest posted a full-fare mix of 17% compared with 24% for the year prior.

Southwest's fellow low-cost operator AirTran Airways saw its average fare fall 13% year-over-year to $86 during the third quarter. But the carrier still netted a $10.4 million profit on an 11% decline in revenue.Carrier chief financial officer Arne Haak also believes that while the worst revenue declines "appear to be behind us, the pace of economic recovery and the price of fuel remain uncertain".

He warns that since the beginning of 2009 oil prices have increased from $40 per barrel to more than $70, and stresses most of that rise is driven by speculation rather than an imbalance in supply and demand.

US carriers generally exceeded Morgan Stanley's third quarter estimates through "small revenue and costs beats", says company analyst William Greene. However, he warns that the "recent rise in fuel prices and conservative forward revenue commentary leave much to be bearish about".

Yet the sequential revenue trends appear to be holding at least through the fourth quarter. JetBlue joined AirTran in posting a profit for the third quarter after recording net income of $12 million excluding a $3 million gain related to its auction rate securities. Carrier chief Dave Barger cites a cautious optimism about the fourth quarter, estimating JetBlue's passenger unit revenue should decline between 3% and 6%. That compares with a second quarter decline of 5.7%.

FTN Equity Capital Markets airline analyst Michael Derchin expects JetBlue to post the best sequential revenue improvement change at the beginning of the fourth quarter, as his estimates show the carrier swinging from a 10% decline in unit revenue from October to flat unit revenues in November. JetBlue derives the majority of its traffic from the leisure segment, and Derchin sees November as a big month for leisure travel.

Under no illusions

"Southwest is the only airline we are forecasting to post a positive revenue per available seat mile in November," says Derchin. "Although JetBlue and Alaska are close to positive results in November, we believe."For the industry as a whole, Derchin says FTN estimates a mainline system unit revenue decline of 6% in November compared with a 14% decline in October.

US carriers appear relieved the worst revenue deterioration ushered in through the global downturn seems to be behind them. But no illusions exist among management teams at those airlines that sustained stability is achievable in the short term. Delta president Bastian believes the industry is in the "early stages of what will be a choppy and likely uncertain recovery".

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