Monday, March 28, 2011

Airlines' Quarter Signals Strength to Come

By Ted Reed 03/28/11 - 10:16 AM EDT
ATLANTA (TheStreet) -- The first quarter of 2011 may be a defining period in the recent history of U.S. commercial aviation, because it demonstrated that the industry has likely developed a capacity to weather sudden and dramatic cost challenges.

As fuel prices rose rapidly during the quarter, airline fares increased along with them, in "an unprecedented display of pricing discipline in this industry, to make sure we're getting the price of our product covered," said Delta(DAL_) President Ed Bastian at last week's J.P. Morgan transportation conference. "We've had eight [fare] increases since the start of the year, four of those led by Delta."

At the conference, both United(UAL_) CEO Jeff Smisek and US Airways(LCC_) US Airways President Scott Kirby proclaimed they had never seen anything like it. The industry has had "a round of price increases that has been faster than I've seen in 16 years in the industry," Smisek said.

Kirby noted that "the last six to eight weeks have given us one really good data point that the industry has restructured." After oil prices began to rise, "the industry responded more aggressively than I have ever seen," he said, adding that industry earnings this year are likely to be similar to down only slightly from last year. The industry made about $2.3 billion in 2010, reversing a year-earlier $3.2 billion loss.

Historically, airlines as a group have been unable to move quickly to recoup lost revenue because someone always held out, limiting the scope of fare increases. In the early 1990s, floundering, bankrupt Eastern kept fares low as it spent its creditors' money. In the middle of the last decade, Southwest(LUV_), protected by wise fuel hedging at a time when few competitors had capital to allocate to hedging, resisted efforts to boost fares.

Those days appear to have ended, not only because the top seven airlines are financially healthy, but also because the three low-fare carriers -- soon to be two low-fare carriers following the Southwest/AirTran merger -- have generally signed on to more rational pricing.

Not only were airlines able to raise prices during the quarter and access billions of dollars in new revenue from fees for services, they also have continued to maintain an unprecedented level of capacity discipline. For instance, Bastian said Delta will move to reduce second-half capacity by four points "from where plans sit today," with most of the cuts coming in the transatlantic.

The impact of all these improvements is evident in the estimates of analysts surveyed by Thomson Reuters, who project that for the full year, only one of the big seven carriers will lose money. In the generally unprofitable first quarter, two airlines will make money while JetBlue (JBLU_) will break even, they project. In the second quarter, profits are expected at every carrier.

Without question, American(AMR_), the one airline expected to lose money for the year, is also the the industry's most intriguing story.

The expectation of a loss is logical, given that American was the only major carrier to lose money in 2010. Once the biggest carrier, American slipped to third as the other two members of the industry's big three expanded through mergers. American, the only carrier never to submit to bankruptcy, also has the highest labor costs.

An American Turnaround?

Nevertheless, it is possible that 2010 marked the start of a turnaround for American. The carrier finally secured anti-trust immunity for a transatlantic joint venture with partners, a privilege its rivals have enjoyed for years. Soon thereafter, regulators approved transpacific anti-trust immunity for a joint venture with partner Japan Air Lines. That arrangement will be implemented April 1. American has said that the immunities combined with a new route strategy should add $500 million in new income, most of it this year.

Additionally, during 2010, American's pilots elected to replace a union president who had systematically opposed every single change the airline sought to make during his tenure -- even when the changes clearly benefited his members.

So far, analysts are not buying the American turnaround story. Current year estimates range from a loss of $3.36 to a profit of 60 cents, the widest range of any airline, with a consensus loss of $1.17.

But the experts are not always right. Just as an example, they nearly uniformly failed to perceive that during its mid-decade bankruptcy, Delta was remaking itself into a profitable company.

In a report last week, Morgan Stanley analyst William Greene rated American overweight, but urged that the carrier follow Delta and others in reducing capacity. "It is clear to us that the seeming lack of urgency with respect to addressing higher fuel prices is weighing on investor sentiment in AMR," Greene wrote. "We believe that an incremental [second half] capacity revision is necessary to rebuild management credibility and thus, investor sentiment."

-- Written by Ted Reed in Charlotte, N.C.

>To contact the writer of this article, click here: Ted Reed
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