Major U.S. carriers suffered through another grim quarter, reflecting ongoing challenges for the domestic airline sector and ensuring yet another year of losses. Traditionally the strongest for the airline industry, the second quarter was defined by historically high fuel costs, extreme pricing competition and severe weather.
There were bright spots, such as American Airlines parent AMR Corp.'s largest net profit since late 2000, US Airways' modest return to profitability and generally strong industry performance on international routes. Yet, overcapacity remains a serious impediment to improved revenues, and industry leaders said taxes and fees imposed by the federal government unduly burden commercial airlines. With half of 2004 behind them and no sustainable revenue recovery in sight, several large network carriers are left with little or no financial wiggle room.
"This has been the most turbulent period in recent history," said Southwest Airlines chairman Herb Kelleher. "Deregulation finally is coming to the ultimate stage in the airline industry."
Airline executives and analysts do not expect much near-term improvement—particularly regarding revenues. "In the domestic market, there are at least a couple of years of tough sledding ahead of us," said Continental Airlines president Larry Kellner, referring to ambitious growth plans at several low-cost carriers. "As long as you see growth, you will continue to see pressure on the fare environment." Continental CEO Gordon Bethune, citing four failed fare hikes this spring, partly blamed "our own peer group's inability to react rationally."
"Expect yields to be very weak way out into the future," cautioned Delta Air Lines CEO Gerald Grinstein. "There is no other way to analyze that. The premium that a broader-network carrier might be able to sustain is shrinking."
J.P. Morgan Securities analyst Jamie Baker summed up his perspective on a potential revenue recovery as "a concept we'd gladly welcome but have formerly retired."
Without much hope for a more favorable pricing environment, carriers continue to focus on cost containment. Though Delta and Northwest still must address one of their larger cost items—unionized employee contracts—the industry has removed billions of dollars in expenses. Much of the progress, however, has been nullified by fuel prices that have been hovering above $40 a gallon.
"We have a pretty normal recovery, comprised of below-normal revenue and above-normal cost reductions—all being masked by high jet fuel prices," said UBS analyst Sam Buttrick.
"High fuel prices are not an excuse," said AMR president and CEO Gerard Arpey. "Rather, they are a reminder that we must continually work to remove costs and improve the underlying profitability of our business anywhere and everywhere we can."
Airline execs said the high levels of taxes and fees paid to the federal government are exacerbating cost pressures. "How can a government continue to burden an industry as disproportionately as they are?" Bethune asked, referring to the $509 million Continental paid to the government in the first half of 2004. "We are borrowing money to pay the government. It is crazy. People talk about bailouts, but they have given us lead life preservers."
Northwest Airlines CEO Richard Anderson also committed his airline to breaking out government taxes and fees in financial reports, saying that "passengers need to understand that airlines are taxed more than cigarettes and alcohol. We and our passengers pay far more in taxes than the value received" from the air traffic control system.
AA's Arpey explained that 28 percent of a $200 ticket, assuming one flight connection, is allocated to excise taxes, segment fees, passenger facility charges and security taxes. That, he said, is up from 17 percent in 1997 and does not include cargo screening costs, yearly lump sum security charges and revenue lost from air marshals occupying seats. "This is a huge public policy issue for our country," Arpey said, "and a huge burden for our industry as it tries to get its head above water."
The confluence of fuel costs, taxes, competitive pricing and other pressures foster a fair amount of uncertainty about the future structure of the industry. "This fall, we could have a scenario in which three of the six big legacy carriers are in bankruptcy and it is not clear where any of them will end up," said CO's Kellner, referring to Delta, United and US Airways. "It is a very muddy environment."
Delta's quarterly loss easily was the largest, though more than $1.5 billion of the nearly $2 billion deficit was related to non-cash charges for deferred income tax assets and the pilots' pension plans. When factoring out all one-time items, the company's quarterly loss still was deeper than last year's. "The usual seasonal uptick in the second quarter no longer can be counted on," Grinstein said.
Standard & Poor's Ratings Services again lowered Delta's corporate credit rating and analysts were not optimistic. Discussing debt loads and industry fundamentals, J.P. Morgan's Baker said, "AMR's dexterous bankruptcy sidestep doesn't assure the same success at Delta." Said The Benchmark Co. analyst Helane Becker: "We fail to see how the airline can survive without a Chapter 11 filing."
Delta now has lost more than $5.5 billion since the beginning of 2001. Its only profitable quarter in the past 14 resulted from a cash injection by the government to reimburse security expenses.
Northwest's $182 million loss, while narrower than last year, brought its 2004 net deficit past $400 million following three consecutive profitable quarters in 2003. Yet, the carrier was slightly more optimistic about pricing than most of its peers. "Corporate business has been stronger," said Tim Griffin, executive vice president of marketing and distribution, noting that full-fare traffic no longer is declining. "There are lots of opportunities to push up average fares with the extraordinary loads we have been running."
Continental squeezed out a $2 million quarterly profit when excluding a one-time special charge related to an aircraft retirement. "We aren't satisfied with break-even results in a seasonally strong part of the year," Bethune said.
Alaska Airlines fell just short of profitability, posting a $1.7 million loss. It was the company's third consecutive quarterly loss, but Alaska finished in the black when factoring out special items. "These results demonstrate real progress with our plan to reduce costs," said CEO Bill Ayer, "but change in our industry has been rapid, radical and permanent. As we proceed, we will consider every possible option that helps us achieve near-term cost competitiveness."
On the positive side of the ledger, AMR Corp. notched a $6 million net profit for the quarter. "It was a much more difficult quarter than we had expected when we built our original plan for this year," Arpey said. "Considering where we have been in the past, we feel modestly good." AA emphasized its aircraft utilization of 4,000 miles per day per plane, which it said was the highest ever for the company and ahead of Southwest. Despite 57 fewer aircraft, AA this summer is offering more capacity than last year.
US Airways also turned a profit, finishing with a $34 million net gain, but still is in jeopardy of returning to bankruptcy court. "We should have done significantly better in the second quarter, which is traditionally our best," said Bruce Lakefield, US Airways president and CEO. "Absent an immediate and dramatic reduction in costs, this nominal profit is insufficient, and we will likely be faced with additional second-half losses."
Meanwhile, America West Airlines continued its solid performance and impressive turnaround. The low-fare carrier's $5.7 million net gain, while down more than 90 percent from last year, was its fifth consecutive profitable quarter following more than three years of losses. Analysts credited cost control and fuel hedging for the positive result. Though the carrier entered an extremely competitive transcontinental market, which negatively impacted yields, J.P. Morgan's Baker expects America West to increase north-south flying on the West Coast "to exploit the otherwise-enviable yield environment." Baker also said the carrier is picking up share against Southwest in Las Vegas and Phoenix.
For its part, even Southwest had a difficult quarter, with net profitability falling more than 50 percent to $113 million. While revenues increased, so did costs. Cost per available seat mile grew 5 percent to slip above 8 cents. Cost-control is paramount for Southwest, as it is tied directly to its ability to keep fares low.
Bankrupt United Airlines was scheduled to report 2Q results after press time. Though another net loss was anticipated, top sales execs expected to beat the industry average in revenue performance
(see story).Industry execs were not confident in the sector's performance for the autumn months. "Post-Labor Day, all bets are off," said Southwest CEO Gary Kelly, whose carrier led a systemwide fare sale for travel through October
(BTN, July 19). "It is premature to say if the pricing environment will improve."
"We are concerned as we move into the fall about the amount of capacity in the marketplace," added Continental's Kellner. "Clearly, there will be pressure on yields in the domestic market after Labor Day."