With fuel prices still damagingly high, 2005 is going to be a year when US majors must start to deliver, while low-cost carriers too will have to fight it out among themselves
"Same time, next year" is the message from analysts and experts when the recovery of the US airline industry is mentioned. Many had expected this year to be the one in which, as a whole, the industry approached breakeven, but they have put off that hope after seeing 2004 end with a huge collective loss. Before special items, led by a massive write-down by Delta Air Lines, the majors ended the year with a collective loss of $5.7 billion, a little worse then 2003.
The 2005 loss, which optimists had seen as manageable in the few hundreds of millions, is now expected to come in at anywhere between $2.8 billion and $3.4 billion, or worse. "By our estimation, industry profitability, even in 2006, is in question," says Gary Chase of Lehman Bros. None of the reasons for the losses is new, although it is worth revisiting the scale of the prime culprit: rising fuel costs.
American Airlines parent AMR reports that it paid almost half a billion dollars more for fuel in the fourth quarter of 2004 than it would have if the price had remained at the same level as the year before. For the full year, the group's fuel bill soared by $1.1 billion. The result is clear from the string of negative operating margins in the final quarter ranging from over 16% at Delta and 12% at United Airlines through to 9% at Northwest and US Airways and 5% at Continental Airlines (see Analysis tables page 76) American's operating margin for the quarter was negative 6.5%, a notable reversal from last year's positive 2.3%. For the full year too most majors were left showing operating losses (see table above).
One of the few carriers to report a sold profit is Southwest Airlines, which ended 2004 with its 32nd straight year of profits, earning $313 million and showing a modest rise against 2003 if government grants are excluded. However, Southwest was not immune to falling yields. "This is something we shall have to keep our eye on," says the carrier's chief executive Gary Kelly, pointedly adding, "we are grateful to be profitable, but these are not the kinds of earnings we want to turn out." In common with the industry as a whole, the fall in yields was not mirrored by sufficient cost gains, even if load factors and traffic growth made up some of the loss.
Southwest's fuel hedging programme, which uses futures markets to pre-purchase jet fuel, saved the carrier $174 million in the fourth quarter. Southwest has pre-purchased 85% of its jet fuel at prices equivalent to crude of nearly $26 a barrel. But Kelly says: "Even with the best hedge we've ever constructed, we had the highest fuel price per gallon we've seen in 20 years."
Kelly adds that "something's got to give". But that probably is not going to be either United Airlines or US Airways, at least not for the year's early months. The long-held belief and deep hope that a major carrier would simply cease to exist, thus lowering capacity and pushing up fares, is not about to be fulfilled. United entered its third year in bankruptcy with only a hope of emerging by autumn, while US Airways has regained strength with funding from leasing giant GECAS.
For United, the December quarter marked its 18th without a profit. The carrier has lost more than $4 billion since entering Chapter 11 bankruptcy protection in December 2002. It still ended up reporting, excluding special items, a fourth quarter operating loss of $493 million versus an operating loss of $134 million. For 2004, United reported a net loss of $1.2 billion.
In the quarter, its fuel expense was $308 million higher than a year ago and the average fuel price in the quarter was $1.45 a gallon, up 52%. Merrill Lynch analyst Michael Linenberg raised the underlying oil price assumption used in his industry forecast from $40 to $45 per barrel. US Energy Department forecasts put oil at just under $47 a barrel for the first quarter. That is $11 higher than in the first three months of 2003.
Time to deliver
So if 2004 was a year of recovery deferred, 2005 is "the year of execution", says one analyst, Ray Neidl of Calyon Securities USA, saying this is the time when carriers must now start to deliver on the cost-cutting that has dominated their agendas for the past two years. This, however, assumes that the cuts already made will remain in place, but with fuel costs making an uncertainty of a fundamental, the focus must clearly revert to an area in which some have surrendered their hopes: revenues.
One chief executive, Doug Parker of America West Airlines, says bluntly: "In so far as this airline's prospects improve, it will depend on improvement in revenues and in yields." He points to the industry-wide problem of limited growth in yields. Chase at Lehman Brothers is predicting average growth in revenues per seat of about 1% in the opening quarter and even that is better than expected. For the majors, the 2004 fourth quarter decline was about 3.5%.
At JetBlue Airways fourth quarter unit revenues dropped by 7%. Meanwhile, Continental, the legacy carrier that has long shown the strongest gain in unit revenues, saw a rise of about 4% in January, but that said, it still lost more than $3 million a day in the year's opening month.
For the legacy carriers, a fare simplification and reduction initiative led by Delta will likely crimp revenues for much of this year, though it may eventually stimulate revenues. For the low-cost sector, though, the revenue challenge is more complex than usual, as low-fares activity increases. A relatively new phenomena is that they are increasingly coming into confrontation with each other on a national basis. As Parker says: "When you have seven or eight low-fare carriers flying around, it's just a matter of time before they start flying up against each other."
Parker has direct experience of this. America West vies against Southwest almost every place it flies. Other low-cost carriers will see each others' presence more and more this year.
In January alone, the low-cost carriers increased their capacity by almost 10%, compared to 2.3% at the legacy carriers. The capacity growth will only continue. JetBlue is to add the first of a huge influx of Embraer 100-seaters that will give it access deep into secondary markets. AirTran Airways is adding Boeing 737-700s to its smaller 717s, while Frontier Airlines is accelerating its Boeing replacement plan and should add 8% more capacity this year, just behind Southwest's 10% growth in available seats. All told, the low-cost carriers have 488 new aircraft on firm order, equivalent to 55% of their current fleet, and options for several hundred more.
With its new aircraft, AirTran plans to grow by 19% in 2005, while JetBlue, which takes seven of its Embraer 190s plus 15 more Airbus A320s this year, should increase its capacity by almost 28% over 2004, predicts JP Morgan's Jamie Baker. Now in its fifth year and one of the best-known airline brands in the nation, JetBlue scratched out a profit in the fourth quarter, its smallest quarterly increase since going public in 2002. Still, chief executive David Neeleman sees profits in each of this year's quarters.
AirTran too is poised to become a nationwide presence, not simply a southeastern phenomenon. AirTran is taking some major strides into the Dallas/Fort Worth market where it will take up some of the gap left by Delta's pull down of its mini-hub there. That is a bold move by AirTran, a move that America West itself declined, despite what Parker called "the best set of incentives we have ever seen from an airport".
Low-cost competition
As the legacy carriers shift capacity into the overseas markets that are the centre of their 2005 growth plans, the domestic market will increasingly be shaped by competition among the low-fares, low-cost carriers themselves. International capacity increased by about 22% in 2004, and is forecast to grow by 12% this year. United alone plans a 14% international increase.
The low-cost carriers, limited to the domestic market plus a few "hot sands" destinations, will fight it out. If the competition becomes as bloody for them as it has been for the legacy carriers, others may echo a contention from Parker at America West: "We just don't need seven low-fare airlines in the USA. It's just too many. This will likely consolidate down to two or three carriers; Southwest will be one and we plan to be one of the others."
DAVID FIELD WASHINGTON
Source: Airline Business
