The benefits of Chapter 11 reorganisation along with the generally buoyant economy and overall industry-wide health have put both Delta and Northwest Airlines on their way to profitability
Bankruptcy - sometimes called "The B Word" and never a good thing in the conventional business wisdom - may not be so bad after all. Both Delta Air Lines and Northwest Airlines are on schedule to emerge from bankruptcy this summer.
Northwest in particular has benefited from protection from debtors and creditors, posting a 2006 profit, its first since 2000. Not counting the one-time costs of bankruptcy reorganisation, Northwest Airlines parent company NWAC earned $301 million before taxes for 2006, enough to let it promise to share profits with its employees.
Since seeking the protection of the bankruptcy courts in September 2005, Northwest has slashed $2.4 billion from its annual costs, some $1.4 billion of that coming from labour. Its wages and benefits fell by 28% for the year, while its aircraft costs fell by 43%. Both of these were achieved through the powers that bankruptcy gives a company to force suppliers and workers to the bargaining table to negotiate lower rates for such things as airliners, services or even real estate.
Regional airline partners that derive most of their income from flying on behalf of Northwest had little choice but to take a hit to their revenue, as did Mesaba and Pinnacle, while aircraft lessors could only talk about cuts if they were to keep their aircraft flying and out of desert storage. The carrier, based near the Minneapolis/St Paul airport, cut capacity for the year by 7.5%, and even though traffic declined as well, revenue rose (by 4%) as did its load factor, reaching 84% for the year, up from 81.5% the year before.
Bankruptcy of course entails extraordinary expenses and these added up at Northwest. One-time restructuring charges of $3.17 billion brought its bottom line to a net loss of $2.8 billion, comparable with 2005's net loss of $2.56 billion. Still, Calyon Securities analyst Ray Neidl believes Northwest "has achieved a competitive cost structure", including a 14% cut in unit costs annually, not counting fuel. CreditSights analyst Roger King says Northwest is "hitting on all cylinders now. They will be a stronger company coming out of bankruptcy."
At Delta, which declared its bankruptcy within hours of Northwest's filing, the process has also been beneficial. The airline says it is ready to emerge from court protection by summer. Atlanta-based Delta posted a fourth quarter operating profit of $2 million. While restructuring costs resulted in a net loss of almost $2 billion, Delta's unit costs have declined as unit revenue has increased. In the quarter, costs fell 10% to $4.13 billion. Revenues rose 5% to $4.1 billion.
The carrier is forecasting it will again be profitable on a net basis this year to the tune of $456 million, according to an analysis Delta submitted to its bankruptcy judge. Delta's progress has been strong enough that it won bankruptcy court permission to finalise a Bombardier order for as many as 30 CRJ900s worth $1.1 billion, with options on 30 more. Similarly, Northwest was cleared to order some 72 regional jets in the 76-seat range from both Bombardier and Embraer.
Both carriers plan limited growth, with most new aircraft taken on only as replacements. Northwest will begin taking Boeing 787 Dreamliners but not for more than a year, while its close-in deliveries are limited to the regional jets and Airbus A330s.
In fact, much of Northwest's international expansion rests on it using its existing Boeing 757 fleet in transatlantic service to secondary destinations. Its limited growth along with revenues rising in line with the rest of the industry gives it the confidence to make some positive projections. Northwest predicts 2007 pre-tax profits of $986 million (not counting one-time bankruptcy expenses), rising to almost $1.4 billion by 2010. Northwest reported 2006 revenue of $12.5 billion, and projected $14 billion by 2010. More notably, it projected a profit margin of 9.9 % by 2010, up from 2.4% (not counting bankruptcy expenses) last year.
Standard & Poor's analyst Phil Baggaley says "their near-term expectations for revenues and expenses and margins are broadly plausible. However, I'm somewhat more cautious about the longer-term prospects. By 2010 we may well be in another industry downturn, based on historical patterns. And it gets harder to make further cost-cutting or other revenue improvements once you've captured the low-hanging fruit."
Market value
Still, Northwest believes it will be worth about $7 billion when it leaves bankruptcy, a valuation that would make it more valuable than the slightly larger Continental Airlines, which has a market value of $4 billion. By contrast, Southwest Airlines has a market value of $12.5 billion, and American around $9 billion. Delta sees its market value when it comes out of bankruptcy as somewhere between $9.4 billion and $12 billion.
Southwest led the group with a fourth quarter net profit of $57 million. American was also in the black, surprising analysts with a $17 million profit. US Airways was the only other major in the black, reporting a $12 million profit.
Steenland says Northwest's transformation was due largely to the sacrifices of its employees and said they would receive "the equivalent" of a 20% economic interest in Northwest. This planned payback would include $563 million in profit sharing, equivalent to 10% of the carrier's predicted earnings over five years, including the employee share of unsecured bankruptcy claims. This would total some $1.5 billion in payouts by 2011.
Steenland notes that Northwest had led the lobbying effort to get a pensions reform passed by Congress, a law that may have softened the blow of pay cuts by preserving pensions for some 73,000 Northwest employees. The airline, unlike Delta, did not terminate its pension plans. However, these retirement schemes will still be underfunded going forward, notes Baggaley, presenting Northwest with some future obligations.
Still, both carriers face the downside of profitability: employees want to share wealth. The $44 million that Northwest plans in profit-sharing pales in comparison to the sacrifices of its pilot union, which took pay cuts of 24% to give the carrier some $608 million in annual savings, according to US Air Line Pilots Association chairman Dave Stevens. Northwest flight attendants also took pay cuts of almost 40%, the union said in an "outraged" statement.
Delta's employees, far less unionised, have not protested as vocally, rallying around their management in efforts to stave off an unwanted takeover offer from US Airways. Airline workers everywhere have followed news of a financially strengthening industry with a close eye. Air Line Pilots Association national president John Prater says: "The only way for these companies to succeed in the marketplace is to restore the concessions that pilot unions gave to their carriers to help them survive."
Source: Airline Business
