The U.S. airline sector is bracing for the traditionally more challenging winter months by finally raising airfares and, in some cases, trimming capacity growth, but stinging oil prices, enormous debt loads and intense competition threaten to drag additional carriers large and small into bankruptcy. Big Six airlines that already reported third-quarter earnings generally experienced deteriorating financial performance and held little hope for brighter skies.
The outlook is particularly bleak for bankrupt US Airways, which could liquidate before spring, and Delta Air Lines, poised to begin its own Chapter 11 reorganization. "There are just too many forces at work to think that something significant won't happen next year. We will see failures in both camps," Southwest Airlines CEO Gary Kelly told BTN last week, referring to both legacy and low-cost carriers. "We will have multiple airlines that have significant reductions in some form or fashion, either selling off pieces to survive or just complete liquidation."
"The road ahead does not look all that easy and even our low-cost cousins are starting to see losses," echoed Continental chairman and CEO Gordon Bethune. "Fuel prices continue to increase faster than we can lower our costs. At a $50 a barrel through 2005, no one survives unless you change the revenue picture."
The industry is beginning to take steps to do just that by pushing through price increases. Taking advantage of a recent U.S. Department of Transportation ruling that allows airlines to separately file international fuel surcharges in general rule tariffs, some major U.S. carriers imposed roundtrip fuel charges between $15 and $25, following the lead of several foreign carriers.
In the domestic market, airlines implemented a flurry of fare hikes in the past two weeks. As opposed to earlier attempts throughout the year, the latest pricing actions—affecting most business and leisure fares—either gained support from or were initiated by Northwest Airlines and certain low-cost carriers.
AMR CEO Gerard Arpey called the recent fare hikes "modestly encouraging signs on the revenue front."
At the same time, the industry's two largest players—American and United—each announced capacity reductions, which, in theory, should help the ailing industry rebalance supply and demand and regain a degree of pricing power.
"There is a growing disconnect between industry capacity growth in the domestic marketplace and overall economic growth," Arpey said. "While the economy has grown roughly 3.5 percent this year, available domestic seat miles are up more than 6 percent. Making matters worse has been the competitive behavior of some carriers either in or on the verge of bankruptcy."
After sidestepping its own bankruptcy filing 18 months ago and losing $214 million in the third quarter, American Airlines in January will reduce domestic system capacity by 5 percent. Early next year, the carrier will remove the equivalent of 15 narrow-body aircraft from its mainline operations, and regional affiliate American Eagle will not take delivery of 18 Embraer regional jets. Service reductions will be targeted at specific point-to-point markets "less essential" to the airline's network, including cities in close proximity to other American markets.
"We decided to stop trying to compete in secondary markets like New York JFK-Long Beach," Arpey said. "We have to draw a line in the sand around our strengths and not retreat." To that end, AA plans to add even more daily flights than previously announced at its primary Dallas Fort Worth hub, filling a void left by Delta and protecting against low-cost carrier incursions.
American also will almost entirely reverse the ill-fated initiative to increase legroom in coach by adding seats back to MD-80, Boeing 737, B767 and B777 fleets. The airline said it had added the extra legroom in a different environment and it no longer can afford a "density disadvantage."
Other measures American is taking include unspecified workforce reductions. The carrier expects a fourth-quarter loss "significantly larger" than the deep deficit in the third quarter.
Meanwhile, bankrupt United also is cutting domestic capacity in favor of growth in more lucrative international markets, a strategy adopted by several major network carriers
(BTN, Oct. 18).Continental and Northwest airlines, however, each plan capacity increases for 2005, though both said the adjustments would be modest, with domestic seat miles in particular growing no more than a few percentage points. Continental lost $16 million in the third quarter, including special items, and warned of significant full-year 2004 and 2005 losses. Northwest dropped $46 million.
Profitable Southwest Airlines plans to "press the development of its route system" and add at least 29 new aircraft to its fleet next year, Kelly said.
The more surprising announcement came from bankrupt US Airways, which evidently is attempting to grow away from the financial abyss. With the clock ticking toward a possible liquidation, the airline's network overhaul calls for an overall 7 percent capacity increase by February, 230 more daily flights, added lift in key business markets—notably in and out of Reagan Washington National—and new routes from Fort Lauderdale to Latin American destinations.
Though US Airways said much of the new capacity would be generated by switching to larger aircraft and increasing utilization rates, many around the industry continue to question the wisdom of adding so much capacity amid intensely competitive pricing.
"US Airways is talking about increasing their flying out of Philadelphia by 32 percent in February," said Southwest's Kelly. "I am not expecting traffic to increase 32 percent in February."
Assuming the status quo on the US Airways front, J.P. Morgan Securities analyst Jamie Baker said, "2005 industry capacity tentatively is expected to rise by no less than 5 percent."
"There are even more seats being added in the fourth quarter and then again in the first quarter," Southwest's Kelly noted. "The supply of seats will exceed the demand for travel and you will continue to see a diluted revenue environment."
Continental's Bethune disagreed, saying "by default or by design," domestic U.S. capacity would decrease next year. He was referring to the possible shutdown of one or more U.S. carriers. On the smaller end, analysts have questioned the financial health of fledgling Independence Air. At the same time, ATA Airlines is rumored to be in talks about asset sales, with America West Airlines cited as a possible buyer. "Anyone who acquired ATA would assume its loan obligations, including the remaining unpaid balance—estimated to be $123 million—of its Air Transportation Stabilization loan," said Helane Becker, analyst with The Benchmark Co., who said ATSB likely would be willing to work with ATA and a potential acquirer to finalize a deal. "We expect that any decision on a sale of ATA would be forthcoming fairly shortly." Within the major carrier ranks, few are safely clear of following United and US Airways into bankruptcy.
"Each of those carriers are very different," said Continental president Larry Kellner. "ATA has lots of Chicago Midway connecting traffic, Independence Air has a regional focus, US Airways is big on the East Coast. It is a lot like a chess game."
Indeed, any carrier with a comparably healthy prognosis is running all sorts of scenarios to determine how best to position itself for the coming shakeout.
Meanwhile, analysts continue to say a Delta bankruptcy filing is more likely than not, and could occur as early as this week. The airline did not conduct its usual conference call to discuss third-quarter results, which swelled to a $646 million net loss, including special items. All told, the world's third-largest carrier has lost nearly $3 billion in its fiscal year to date and more than $6 billion since late 2000.
Delta's primary concerns are an enormous debt load, dwindling cash reserves and a new pilots deal. "As Delta's financial situation continues to deteriorate, time is of the essence," said CEO Gerald Grinstein.
UBS analyst Robert Ashcroft said a deal with the pilots union is likely and a Chapter 11 filing, while probable, is not "a totally foregone conclusion," but he said Delta's unrestricted cash level of $1.45 billion is "already in the danger zone." He said a near-term US Airways liquidation would help Delta avoid Chapter 11. "Unfortunately, if US Airways collapses at all it is likely to do so too late—January or February—to do Independence Air and Delta much good."