Escalating Jet Fuel Prices Negate Air Revenue Gains

The U.S. airline industry limped through another quarter after taking a pounding from hurricanes and high jet fuel prices. While Southwest, Continental and Alaska airlines posted profits, American parent AMR and Northwest Airlines didn't. JetBlue's net income was barely in the black and is likely to give way to losses in the current quarter, while bankrupt Delta and United each have not yet reported what are sure to be uninspiring third-quarter numbers. More financial deficits are expected at most operators through year-end.

Yet, J.P. Morgan Securities analyst Jamie Baker said he sees reason for optimism. For starters, he said industrywide revenue per available seat mile would be up 6 percent in 2005—largely a result of fare hikes—and estimated 2006 RASM would rise 7 percent amid "flat industry capacity, inclusive of legacies, LCCs and regionals." Domestic capacity, in particular, could be down as much as 2 percent next year, "the first instance of sustained domestic shrinkage in a non-recessionary environment."

"A model that was supposedly not built for $40 oil appears poised to function at $60," he said, predicting that both AMR and Continental would post net profits in 2006.

For now, however, AMR is in the red. All told, the company dropped $153 million in the quarter, which is a significant improvement from a $214 million quarterly loss from one year earlier, but still "unacceptable," according to CEO Gerard Arpey. "The fact that we were unable to sustain profitability despite robust customer volumes says a lot about our inability to pass on fuel-price increases to consumers."

Nevertheless, American posted solid revenue performance, including a 15 percent year-over-year jump in passenger revenue, an 8 percent improvement in passenger yield and record load factors. "We saw our first significant yield increase in some time," Arpey said, "but there is still a disconnect between the price of fuel and the price of air travel."

Though American expects to report deep losses for the fourth quarter and throughout 2006, its $3.4 billion in unrestricted cash for now is seen as sufficient liquidity.

Bankrupt Northwest posted a $475 million net loss, up tenfold from one year ago. Cost increases more than offset positive passenger yield.

At Continental, a $61 million net gain represented the company's second consecutive quarterly profit. Its $2.8 billion in passenger revenue—up more than 15 percent from a year earlier—was a new Continental record.

Calyon Securities analyst Ray Neidl said that "relatively low unit revenues, excluding fuel, combined with what is perceived as Continental's premium service and Newark airport serving the New York business market, helped Continental beat expectations."

Like others, Continental suffered hurricane-related operational disruptions. Specifically, Hurricane Rita forced the airline to suspend service at its main Houston hub for 36 hours, costing roughly $25 million.

Continental this month announced it had boosted liquidity by raising $204 million through an offering of 18 million shares. Its year-end cash balance is expected to be roughly $1.6 billion.

During a conference call with analysts and media, Continental CEO Larry Kellner said the airline "always worries" about the size of competitors. "American is almost twice our size, so we will keep our eye on other combinations," he said, referring to the possibility of additional industry consolidation. "America West-US Airways is about our size, so we feel good about competing with them. I would not want to be competing with too many carriers that are double our size."

"We do not discount the possibility that the management team may be considering a merger partner," said Calyon's Neidl. "Its route system would make the company a nice fit with many of the other legacy carriers and would bring the prized Newark Liberty Airport into any marriage."

Meanwhile, Southwest remained as the nation's most profitable carrier, netting $227 million in the third quarter. It benefited from record passenger revenue and load factor, higher passenger yield and the most enviable fuel-hedging program in the industry. "We also benefited from a reduction in the glut of competitive seat capacity," said CEO Gary Kelly.

At JetBlue, third-quarter net income declined to $2.7 million from $8.1 million one year earlier. The carrier posted stronger passenger yield, unit revenues, total revenues, traffic and capacity growth but experienced higher unit costs, even when excluding fuel. For the fourth quarter, the airline anticipates an uncharacteristic net loss.

"If oil prices remain at their current levels," according to Neidl, "we believe that JetBlue will be forced to try to raise prices, which will bring down its high load factors and which will probably force them to slow down its aggressive growth rates."

AirTran reported a net loss of $200,000, significantly narrower than last year's $9.8 million third-quarter loss. The airline set internal records for total passengers, load factor and revenue, which jumped more than 50 percent to $375 million.