Airline losses have arrived early as the US economy starts to slow, but Chris Tarry of Commerzbank argues that the turning point could also come sooner than it did in the last protracted recession

Latest results from the US majors seem to leave no remaining doubt as to the where the industry is headed. The traditionally robust June quarter left the carriers showing a sizeable net loss. And as the economy continues to slow down, it seems inevitable that airline results everywhere will get worse before they get better. The more interesting question, especially for equity analysts, is how long it will take this time for industry profits to re-emerge?

Admittedly there were some exceptional factors at play in the US second quarter. Delta Air Lines was clearly hit by the effects of the Comair pilots strike, while United Airlines has been counting the cost of last year's stratospheric hike in pilots' pay, plus the distraction of its merger attempt with US Airways. TWA has also now been absorbed by AMR and exits the table.

However, the prime issue remains the US economy. Revenues were down for the industry as a whole, with only Southwest and Alaska Airlines showing strong growth. Together with Continental Airlines they were the only carriers to stay in the black.

Even the better-than-expected results at Continental tells a story. Operating profits fell by half, reflecting a 5.2 percentage point deterioration in the relationship between the breakeven load factor (worse by 2.9 points) and the achieved load factor (worse by 2.3 points).

There is still the need for some in the industry to have their rendezvous with reality over just how bad the results might become - in this may occur when there is some clarity over the traffic and yield numbers going into the weak fourth quarter. The risk to profit forecasts clearly remains on the downside.

However, for stock market investors the issue is not how bad things are today, but the ability to anticipate the likely changes ahead. Equity analysts are therefore always looking for turning points and for any suggestions of a change in the leading indicators. In this respect there is evidence of an important change in US consumer behaviour compared with the last downturn.

In making any comparison with the previous down cycle, it is necessary to isolate the distorting effects that the Gulf War had on international traffic. However, that does not apply if the focus is put on the US domestic market. Another dimension that is important to recognise is the extent of excess capacity that existed in the market place a decade ago which resulted in a greater absolute amount of price-stimulated traffic.

It is also clear that at the start of this review period the growth rate of traffic (measured in revenue passenger miles/km), was running ahead of economic growth, (measured by GDP growth). This might reasonably have been expected, even in the maturing US domestic market given a traffic multiplier of 1.5x against GDP.

In the early 1990s, the economic slowdown was already well established before the rate of traffic growth started to decline and then fell. Economic growth rates had actually peaked in 1989, while traffic growth was still riding high into mid-1990. Over the next couple of years traffic began to turn the corner and that did indeed coincide with a recovery in economic growth rates. However, traffic was generally recovering by less than GDP right through until 1993. US domestic traffic growth did not again reach the high point of 1990 until 1994.

This time around it appears that there may be a very different pattern. Not only does it seem that the economy no longer drives US domestic traffic with such a strong multiplier effect (the growth rates appear close to parity), but traffic growth also seems to have been reducing much early. It has fallen markedly over the last three quarters, well in advance of the economic slowdown.

This suggests that there has been a change in consumer behaviour. In particular, that by reducing travel in advance of the onset of recession, US corporations are ameliorating the impact of the weaker economic environment on their business.

The key for the future is whether this increase in the lead times by which companies anticipate and react to economic change will also hold true when the slowdown eventually bottoms out? If so, then perhaps the turning point for airline profits may not be so far away.

Source: Airline Business