US network airlines had scant opportunity to enjoy fuel prices falling from record highs before the global economic downturn triggered a collapse in demand and wiped out their profits in the first quarter.

Capacity discipline by those carriers that began when fuel hit $140 per barrel during the second half of last year did little to shield those airlines from plummeting traffic during the quarter. Yields were also pressured by deeper-than-normal discounting as airlines attempted numerous fare sales to stimulate demand.

All the major network carriers and Southwest Airlines posted losses for the quarter as losses on fuel hedges from deals brokered during the height of fuel spikes carried over into the first quarter.

Delta Airways 

But while no single executive at those airlines is bold enough to officially declare a bottoming out of demand or near-term improving fortunes, carriers appear to have tempered optimism over the fact that "things aren't getting worse", says Delta President Ed Bastian.

Signs that the speed at which demand is dropping are somewhat encouraging as Bastian highlights that corporate travel trends continue to soften, "but the pace of decline in business yields and bookings has definitely slowed". However, he says "I think I would echo the comments of our peers that we're not ready to call a bottom yet."

Still, aside from making any attempts to declare a halting of falling demand Delta is predicting profitability in 2009 as "merger synergies and capacity reductions offset the deterioration in revenue" declares Delta chief financial officer Hank Halter. Delta and Northwest Airlines merged in October 2008.

Attempts by some carriers to raise fares during the last few weeks are promising, as US Airways President Scott Kirby believes those efforts are "attitudinally important".

Kirby expects load factors for US Airways in the second quarter to meet or slightly exceed last year's levels. "That tends to be a precursor to a stronger fare environment," he explains, but also cautions that "we really haven't seen that yet. The fare environment is still pretty ugly at the moment."

Asked for his view of pricing chief executive of American Airlines parent AMR Gerard Arpey says: "One of the seminal problems in this industry, and has been for many years, is we don't charge enough for our product".

Continued Low-cost Carrier Strength

While the US majors grappled with losses in the traditionally weak first quarter, both AirTran Airways and JetBlue Airlines reported milestone profits for the first three months of 2009. For AirTran, its $29 million profit represented an all-time first quarter record net income for the company. JetBlue's $12 million net income was the first time the carrier posted a first quarter profit since 2005.

Despite the marked shift by low cost carriers into more hybrid models through codesharing pacts and aggressively pursuing more lucrative business travelers, their fundamentals provide a shield not easily accessible by their network counterparts.

Morgan Stanley analyst William Greene believes the domestic focus of low cost carriers "should drive [their] outperformance versus the more internationally exposed [airlines], as the worst may be yet to come for international trends, and Swine Flu adds additional international travel demand risk".

Even before it posted a first quarter net loss of $794 million, Delta Air Lines said it planns a further 10% cut in its international capacity beginning in September. A weak performance in transatlantic markets forced Continental to revise its capacity reductions for that region by a single percentage point, resulting in an overall decline of 7%-8% for the September time period.

US Airways, who has less international exposure than its network peers, also sees some traction in domestic demand. "The domestic entity is performing so much better than the international entity", says carrier chief executive Doug Parker.

Bob Fornaro - AirTran 
 ©Terri Hanson

A significant smaller exposure to international traffic and a "clear advantage" from low cost operations in a soft demand climate has led Morgan Stanley's Greene to recommend "for the past few weeks that investors begin rotating out of legacy airlines into shares of domestically leveraged low-cost leisure carriers".

AirTran CEO Bob Fornaro (left) does not argue the carrier's strict cost discipline supplies a significant benefit in the current environment. Its average 6.73 cent unit costs are one of the best in the US airline industry. Fornaro expects AirTran to achieve profitability in every quarter this year as he says "AirTran will do very well over the next two years if there is no revenue improvementthis is by now a cost-based environment, ideally suited for us right now".

JetBlue's first quarter results beat Morgan Stanley's estimates as Green says "lighter than expected revenues" were offset by improved unit costs excluding fuel. JetBlue chief executive Dave Barger echoes the predictions of his counterpart at AirTran boasting "that we expect to earn a profit in every quarter of 2009".

Pulling The Ancillary Lever

Both network and low cost carriers say they expect to strengthen their ancillary revenues to buoy lacklustre passenger revenues as any revival in fares or overall demand remains difficult to predict.

US Airways expects to net $400-$500 million annually from ancillary revenues, and recently tacked on a $5 charge for passengers opting to pay checked luggage fees at the airport versus making the payment while checking in online. In 2009 the carrier plans to focus heavily on preferred seats, Kirby explains, as late last year it expanded the number of seats allotted to that category in its total seat pool from 8% to 16%.

Total ancillary revenue per passenger at United Airlines during the first quarter reached $14, a 60% rise year-over-year. Carrier chief executive Glenn Tilton believes United's transition to a cashless cabin on domestic flights that began during the first quarter will bolster its ancillary revenue strategy as flight attendants now have the ability to upgrade passengers to the carrier's Economy Plus seating onboard.

JetBlue finds that even though customers are generally paying lower ticket prices, many of its ancillary revenue initiatives "have shown less sensitivity to the weakening economic environment", says chief executive Barger. He highlights customers "have continued to purchase products to enhance their experiences" such as JetBlue's extra legroom offering.

JetBlue expects its ancillary revenues to rise 20% in 2009 as product unbundling should help offset an estimated decline of passenger unit revenues of 1%-4%. The carrier's total estimated unit revenue fort this year is expected to fall within a range of 1% growth to a decrease of 2%.

Yet JetBlue and all other carriers remain cognizant of the fact that any of the initiatives they're undertaking either on the cost or revenue side will not wipe out the challenges airlines face this year. "We have seen some signs of stabiliSation as the revenue environment appears to have bottomed out," notes Delta chief executive Richard Anderson. "But it is still a bit early to call, and we expect to face significant headwinds throughout 2009."

Click here to see our US carrier review of the previous quarter

Source: Airline Business