Expectations of an upturn in airline fortunes have been pushed back after the latest round of quarterly results from the US majors
"There goes 2003," in the words of one Wall Street analyst, faced with another dismal performance by the US majors in the second quarter. With these results, expectations of any improvement in the near-term have begun to recede leaving few now optimistic that 2003 will show much in the way of recovery either.
Even after stripping out special charges, the majors were left showing a $1.3 billion deficit in the June quarter, by far the largest on record for what is traditionally the industry's most lucrative period. Losses in the opening quarter added another $2 billion to that figure. And with special charges, the overall first- half loss stands at just below $4 billion.
Analysts have been quick to raise their estimates for full-year losses. The consensus for 2002 now appears to be moving towards and underlying loss of $5.5 billion on top of last year's $6 billion. And UBS Warburg analyst Sam Buttrick is not alone in estimating losses of $1.6 billion to follow in 2003, close to three times higher than many had earlier expected. "We would be hard pressed against the current backdrop to describe our estimates as conservative." he adds.
Traffic sluggish
Traffic for the majors showed little improvement in the quarter, remaining close to 10% down, while capacity cuts too have come down to about the same level. While the majors saw seat costs trimmed by a percentage point, passenger yields were down by a heavy 7.5%, with US Airways edging into a double-digit decline. The figures are in stark contrast to the relative health of low-cost leaders such as Southwest, AirTran and the rapidly expanding JetBlue. Although heavy discounting took its toll on yields even for these low-cost heroes, they kept growth rolling and unit costs falling.
But even more ominous news for the majors comes from what the latest results round does not show. The wrenching self-examinations and sweeping internal reviews launched last year with considerable public attention, seem to have produced few hard results so far. American Airlines chief executive Don Carty restricted himself to telling staff that American will not follow the model laid down by Wal-Mart, the aggressive low-cost US grocery chain, and mirrored by Southwest. "There are elements of our full-service airline that have tremendous value," he says.
United Airlines also shows no sign that a major revolution is imminent. "We have not identified any alternative that can bring in as much revenue as our current highly segmented pricing structure," said president Rona Dutta.
That is United's answer to the growing cry that the airline pricing model is broken and must be fixed. Dutta then said that, after a four-month study of the entire airline, management had concluded that United's one true weakness is "that we are a high-cost carrier." Internet analyst Holly Hegeman of Planebusiness.com retorts: "It took four months to figure this out?"
Dutta adds that United cannot simply overhaul the airline. "It's hard enough to be a high-cost carrier in a high-end business market. It would be worse to try to be a high-cost carrier in a low-end leisure market," he says, also defending the hub system against calls to follow the low-cost carriers towards more direct flying. The cost of doing so would "dwarf" the benefits, he says.
Hub advantage
Delta chairman Leo Mullin adds his voice in defence of the network model. "The hub-and-spoke system is a source of enormous competitive advantage. If something absolutely strategic has arisen to have changed the entire model of aviation, we're not ready to decree that yet." Delta continues to study its options, including enlarging its low-cost Delta Express "airline within an airline". But when the review is done, Mullin says that Delta will have "no dramatic announcement to make. Instead, we'll just kind of slog through this".
That slogging through appears to focus on a series of less ground-breaking gains, such as United's promise to deploy new technology on the ramp or nibbling at costs by eliminating paper tickets, saving $5-8 a booking. As Dutta says: "We are not changing our business model. Taken together, the cost cuts add up to a tidy sum of money - a significant amount in total."
This approach draws a passionate response from Buttrick, who says the industry is too focused on cost cutting. "Lower costs don't fix broken revenue models," he says, arguing that the "familiar refrain" about costs being too high could equally be viewed as a case of revenues being too low.
In the second quarter, the majors overall registered a 15% fall in revenues. "Airline management seems better equipped to deal with high costs than low revenues. Yet it is the revenue environment that will define the industry's returns more so than tweaking costs. It is difficult to be impressed with current management's grasp of the revenue picture," Buttrick laments.
Jamie Baker at JP Morgan Securities too worries about the lack of action by the majors. "The magnitude of this quarter's loss reflects the inherent incompatibility of low fares and the legacy carrier business model. "Unfortunately, most carriers continue to retreat, ignoring the healthy demand for low fares," he says.
Northwest Airlines is among those now attempting to hold the line on discount fares after the give away prices of last year. Executive vice-president for marketing, Tim Griffin, says the carrier cut the number of days it was on a system-wide sale from 80% in the final quarter of 2001 to under 50% over the first half of 2002.
Griffin says that revenue increases would come more from management of fares at the lowest end of the scale rather than any broader approach. About 22% of Northwest customers pay less than the lowest list price or "rack rate" says Griffin, estimating that this category could possibly be a third of passengers, industry-wide.
Northwest could be the first major to return to profitability, says chief executive Richard Anderson. The carrier was nominally profitable in June and was showing profits for July and August going into the current quarter. Continental Airlines also was profitable in June, but chief executive Gordon Bethune does not expect long-term profitability to return soon. "I don't see any signs of it on the horizon," he says.
One noticeable ray of light seems to be the sick man of the south western states, America West Airlines, which recovered dramatically from a 22% revenue fall in the first quarter to end the second only 7% down - less than half the average fall across the majors.
In March, the carrier had pushed through a basic change in its fares structure: cutting as much as 70% off fares bought within 14 days of travel, making fares available on a one-way basis and eliminating the hated Saturday-night stay requirement.
Corporate weakness
Looking ahead, United's Dutta sees a profound change delaying the recovery: "Airline revenues are linked to corporate profitability, not - as we long thought - to gross domestic product. Airline revenue is unlikely to recover until corporate profits also recover."
For his part, Air Transport Association chief economist David Swierenga says: "I expect that this year to be a write-off and I really think that next year will also be a fairly large loss. We will make some progress in reducing the size of losses as traffic comes back and the prices come back and as airlines get some labour cost concessions, but not a return to profitability until 2004." UBS Warburg's in-house pessimist Buttrick is even more blunt: "Well, there's always 2005."
REPORT BY DAVID FIELD IN WASHINGTON
Source: Airline Business
