The US majors may look back on the summer of 2007 with fondness, despite a season of discontent for passengers, writes David Field
Summer was when the capacity controls of the US majors began to gather real traction. But now the carriers are entering a winter that will certainly be different and difficult. Oil prices are poised to break the menacing $100 a barrel level as business enters its slow season.
As the third quarter went out with a boom, airline profits had become boasting material, with US carriers vying for the title of best margins. The former bankrupts had completed their restructurings and most laggards such as JetBlue Airways are profitable again. But even with strong margins by any measure, the nation's carriers go into the shank of the year facing a tightrope: fuel is rising faster than fares, and fuel has no cap, while at some point fare increases will be resisted.
Boasting rights for best margin in any event go to Northwest Airlines among the big legacy or network carriers in its first full quarter out of bankruptcy, with a pre-tax margin of 13% and a 57% improvement in earnings over the third quarter of 2006. Its pre-tax profit of $405 million was its highest pre-tax quarterly profit in 10 years and the third highest in its history, said chief executive Doug Steenland.
In fact, Northwest's performance was so strong that it was able to overcome two months of badly interrupted service that cost it about $50 million in foregone revenues and added costs over the summer. Overtime scheduling problems led to a pilot shortage that forced Northwest to cancel hundreds of flights, inconveniencing many thousands of passengers.
Since then the carrier, based near the Minneapolis/St Paul International airport, has reached an agreement with its Air Line Pilots Association chapter on overtime, and is confident enough to have announced performance guarantees for holiday travel.
Steenland boasts that in the capacity game, Northwest has two unique assets: new planes and above all old planes. Not only does it have new Airbus A330s on its international routes, letting it park its DC-10s, but it will be among the first to take on the Boeing 787, he noted.
And until then, it has about 102 fully refurbished DC-9s that it can easily park if it decides to ratchet down capacity as fuel prices go up, chief financial officer Dave Davis said. He told a Goldman Sachs analyst event in early November that the airline could respond to weakening demand by parking some its older, paid-off aircraft if passengers balk at paying higher fares.
"The cost to us of not flying those is relatively minimal," Davis said. "If we see a significant drop in demand, which we haven't seen yet, I think we're in a good position to respond."
When the airline put together its five-year business plan just before exiting bankruptcy court this spring, Northwest planned that crude oil would sell for $63.50 a barrel in 2008. However, futures contracts for 2008 are selling in the high $80s, Davis said.
United Airlines was also proud to have a number of aircraft it could easily park. Chief financial officer Jake Brace said that the airline has just over 100 airliners which are unencumbered by debt "that we could ground whenever we needed to if the demand environment were such that it didn't make sense to fly those planes". The total includes 50 older Boeing 737s, said Brace.
United's third-quarter capacity was down by 5% in North America, and was set to drop by almost 6% year-on-year in this quarter. Even that plan is under review.
At Continental Airlines, where capacity has already been pared with the sale of 15 older 737s, plans now foresee total growth of 3-4% down from an earlier 7%, and almost all domestic growth is to support its international flying, said chief financial officer Jeff Misner.
JP Morgan analyst Jamie Baker estimated that the majors have just over 450 aircraft or about 15% of the total fleet unencumbered or coming off lease next year that could be grounded.
Doug Parker, chief executive of US Airways thinks that airline management sees these numbers written on the blackboard. He told the Goldman Sachs conference: "If indeed everyone stays where they're going to stay in capacity, I think what's really happened here is that we've dramatically reduced the cyclicality of our business".
Discounters pull back
Low-fares carriers are cutting back as well. Southwest Airlines, after two earlier versions of a slower growth plan, will likely pull back even further. Chief executive Gary Kelly said at a company event in November that "every morning, you wake up to a new record crude oil price. The move up in [oil] prices and the futures market for next year is very significant, even though we're 70% hedged at $50 a barrel. We're definitely reconsidering our growth rate for next year."
The fuel crisis has encouraged merger advocates. United's Brace said fuel prices "may help get people to the table". US Airways' Parker said: "If oil is really going to be at $100 a barrel going forward, we have to look at restructuring this business yet again. Perhaps this will compel our industry to do what it has to do and move toward consolation."
And a new factor is about to present itself: Southwest, long the low-fares leader in the nation, is refocusing itself to pursue higher-yield business flyers, the very type of flyer on which the network carriers have focused and from whom they have been able to attract higher and higher fares this year. In early November, Kelly announced a new fare structure that would give the highest paying passengers priority boarding.
Southwest's first-come, first-served boarding process has long been a deterrent to business flyers who do not want to have to get to the airport far in advance of their flight times to be sure of their preferred seat. The airline experimented with an assigned boarding system earlier this year but it was not popular. Southwest has also redeployed aircraft to routes linking business centres.
Brace summed up the two factors stretching the tightrope on which airlines find themselves suspended: "Either the industry passes on the higher fuel prices or we're going to have to lower capacity, but you have to make the equation work," he said.
Certainly passengers will stop paying more at some point, but it has not been reached yet. Airlines have repeatedly said they have yet to see resistance to higher fares, even as they pushed through a fuel surcharge in November. Anecdotal evidence suggests otherwise: a survey by on-line travel agency Orbitz found some flyers saying they would change their plans. JP Morgan's Baker, however, does not worry about demand falling off .
Every $10 increase in the cost of a barrel of oil implies an $18 increase in a round-trip, a realistic goal given recent fare trends, said Morgan. Airlines will not be shy about making up the difference "particularly at a time that supply is being constrained".
Source: Airline Business
