Airline Profits Grounded by Rising Fuel Prices and Bad Weather

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After barely scraping through a two-year recession and a global financial meltdown, the airline industry's struggle to sustain a turnaround is now being threatened by rising fuel prices and nasty winter weather.

Civil unrest in Egypt
combined with surging demand have already boosted oil prices by 20% since last June, setting off alarm bells among the nation's carriers. Now, a series of winter storms that began in December has slashed airlines' revenues by tens of millions of dollars.

Most carriers, other than AMR Corp. (NYSE: AMR), made sizable profits for all of 2010, including records for some carriers. But expectations for 2011 are shrinking now that fuel prices have risen and a relentless series of winter storms have forced thousands of flight cancellations.

Spiking Oil Prices Threaten Profits

Indeed, if oil prices simply hold at current levels, they will increase airline costs by more than this year's projected earnings, threatening the industry's return to profitability, according to the International Air Transport Association (IATA).

Based on oil prices of $84 a barrel, airlines would rake in $9.1 billion in net income in 2011, IATA said in a Dec. 14 forecast.

But every one-dollar increase for a barrel of oil translates to higher jet fuel costs of $1.6 billion. And with crude now trading at about $91 a barrel, costs could increase by $11 billion this year, wiping any profits from the books, according to data compiled by Bloomberg News.

"The story this month is the sharp rise in oil prices," IATA Chief Executive Officer Giovanni Bisignani said in a statement. A sustained increase in oil prices "could spoil the party" even as people start to travel again after the recession. That could further erode the carriers' 2.7% profit margin, which he described as "pathetic."

Since fuel prices account for at least one-third of airline operating expenses, even comparatively small price shifts can have a major impact on profits.

With the protests in Egypt threatening to halt shipments through the Suez Canal, airline officials are worried about a repeat of the fuel price hikes of 2008. In July of that year crude oil prices topped out at over $147 a barrel and sent airlines' earnings into a tailspin.

Wall Street analysts recently lowered their 2011 earnings estimates for a number of carriers, with fuel prices at the forefront of their thinking.

In a recent memo to employees, Delta Airlines Inc. (NYSE: DAL) Chief Financial Officer Hank Halter pointed to the recent run-up in fuel prices as the biggest challenge facing the airline.

And in a recent conference call with investors, American Airlines CEO Gerard Arpey characterized the trend as "the most worrisome trend we see."

While Delta and American Airlines reported increased revenue for the fourth quarter, sales didn't rise quickly enough to offset an average 13% increase in fuel prices.

Delta reported in-line revenue of $7.8 billion but its operating profit missed Wall Street estimates. AMR, meanwhile, beat earnings estimates but its revenue merely met Wall Street forecasts.

In the face of dramatic fuel price increases, Arpey said the most "logical" first step would be to "raise your ticket prices."

In response to crude oil prices nearing the $100-range, most major U.S. airlines have rolled out three waves of fare increases since Thanksgiving.

And just this week, domestic airlines attempted a "significant" fare and fuel surcharge hike, MarketWatch reported, citing an anonymous source.

American was first in line to attempt the latest round of fare increases, raising its airfare by $4 to $10 a roundtrip on the bulk of its domestic route system. United Continental Holdings Inc. (Nasdaq: UAL), US Airways Group Inc. (NYSE: LCC) and Delta later matched the increase with fuel surcharge increases.

Additionally, JetBlue Airways Corp. (Nasdaq: JBLU) added a whopping $70 to $90 per roundtrip fuel surcharge for flights to Puerto Rico and the Caribbean.

That's more bad news for deal-seeking air travelers. Fees for things like checked baggage and blankets already have induced sticker shock on the traveling public.

Stormy Weather Hammers Revenues

Meanwhile, this week's winter storm is halting air travel throughout the United States, slashing the revenues of several U.S. airlines already weighed down by a massive wave of cancellations over the vital holiday season.

More than 5,000 flights, or roughly 20% of those scheduled nationwide, were canceled for a second day in a row Wednesday as a storm battered much of the country, The Wall Street Journal reported. More than 1,000 flights were canceled in New York and hundreds more were nixed in Dallas. Most importantly, Chicago, United Continental's biggest hub, was a no-fly zone.

A whopping 52,742 flights have been canceled at U.S. airports since Dec. 1, 2010, or 4.98% of those scheduled, according to FlightStats, a flight-tracking service. That's the most in five years for the same period and more than double last winter's rate.

"Other than September 11, I haven't seen it shut down to this degree at all. This has really been a major shutdown." Terry Trippler, owner of travel website Airlinerulestoknow.com told Reuters. Trippler said it would take several days for airlines to accommodate the thousands of displaced travelers.

Airlines usually build winter weather delays and cancellations into their annual budgets. But the kind of massive disruptions experienced this year can hit quarterly earnings hard as carriers lose business and struggle with higher operational costs.

"Given that the first quarter is always a tough one even in good years, a major storm that lasts several days and hits several hubs could make or break the quarter," John Heimlich, chief economist at the Air Transport Association (ATA), an umbrella group for U.S. carriers, told The Journal.

Delta, the second-largest U.S. carrier by traffic, recently reported that weather events in the first half of January alone would knock $30 million off its first-quarter profits. It also disclosed that December storms slashed its fourth-quarter profit by $45 million.

United Continental, the largest U.S. airline, said bad weather cut its fourth-quarter net income by $10 million. But that number could grow worse in the first quarter after Chicago was snowed in this week.

A Lost Decade for U.S. Airlines

Rising oil prices and the fierce winter storms are just the latest setbacks for an industry that has been struggling just to survive for the last 10 years.

Although U.S. airlines finished 2010 with nice profits, they have been threatened with extinction in nearly every year of the first decade of the 21st century.

Although 2010 "[was] a very satisfying year. It was an upbeat end to what I think most would agree has been a lost decade for the airline industry," Southwest Airlines Co. (NYSE: LUV) chairman and chief executive Gary Kelly said in a teleconference with analysts Jan. 20.

Only six of the 10 largest U.S. passenger carriers in 2000 are still in business. Trans World Airlines Inc., Northwest Airlines Inc., Continental Airlines Inc. (NYSE: CAL) and America West Airlines Inc. all have merged with other carriers.

UAL Corp., parent of United Airlines Inc., TWA, Northwest, US Airways, and Delta all filed for bankruptcy during the decade.

AMR avoided bankruptcy by radically restructuring in 2003, but has failed to turn a profit for most of the time since.

Only Southwest showed a profit for each year from 2000-2010. AirTran Holdings Inc. (NYSE: AAI), which cracked the top 10 early in the decade, came in second best, losing money in only two of those years. Southwest is scheduled to close a merger with AirTran in the second quarter.

Discount Carriers Shine

Stormy weather will come and go. But while the airlines focus on increasing efficiency and lowering operating costs, fuel price swings – up or down – will have the most influence on where fares, and profits, go from here.

Airlines might be able to cope with fuel prices in the $75-$100 a barrel range by making capacity adjustments, Ray Neidl, a senior aerospace specialist at Maxim Group, told InvestorPlace in a recent interview. But if prices exceed $100 a barrel, it will be much harder to pass increased costs on to customers.

On the other hand, if oil prices dip below $75, airlines could be motivated to increase capacity by bringing big, fuel-guzzling planes back into service, he said.

But even if oil prices surge, some analysts think the major airlines will benefit from the lessons they learned during the crises of the last decade.

Transportation economist George Hoffer, who teaches at the University of Richmond, said he is bullish on the prospects for U.S. airlines, particularly those with strong networks and international routes. That would include what he calls the big three – Delta, United and American.

The mergers of the past decade and the capacity shrinkage of the past two years have the airlines in good position for a strong decade ahead, Hoffer said.

"They may look like they've got problems with respect to fuel, but I think they end the decade on a real high. They have much more economic power. They have much more pricing power." Hoffer said.

Even so, the record for the big airlines throughout the last decade was dismal.

Those carriers, including AMR, Continental, Delta, Northwest, UAL, US Airways and America West, lost $66.7 billion during the 2001-2009 period.

By comparison, the low-cost carriers, including Southwest, Frontier Airlines Inc., AirTran and JetBlue, earned $3.3 billion as a group during the same period, with most of that – nearly $3.2 billion – coming from Southwest.

Investors who want to make a wager on the industry might want to spread their bets with the Claymore NYSE ARCA Airline ETF (NYSE: FAA). Keep in mind, however, the fund is not limited to U.S. airlines, but invests in carriers around the globe.

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