Experts Predict Dearth of Capacity, But Not Profits

<B> Experts Predict Dearth of Capacity, But Not Profits</B>

By Jay Campbell

As experts continue to predict long-term profitability for the U.S. airline industry despite softened leisure demand in and around Asia, they expect corporate buyers for the most part to continue to experience high domestic business fares and tough negotiating by the airlines.

There have been some signs of ticket prices leveling off, however. While American Express' latest airfare index indicated that typical business fares in February, 1998 were 9 percent higher than in 1997, February also was the fourth consecutive month of less than a percentage point increase in those fares.

"Now there is some consistent evidence that the climb in air fares aimed at corporate travelers is taking a breather," said Eric Altschul, vice president of the Amex consulting services group. "Still, the current level of business fares is considerably higher than it was last year."

Some airline executives have credited political pressure by Congress and the Department of Transportation with keeping fares from climbing as much as they otherwise would have. Nonetheless, as first quarter earnings reports trickle in this month, it's clear that high fares are contributing greatly to the airlines' continued profitability.

American Airlines, which enjoyed a 91 percent improvement in profits--$290 million compared with the first quarter of 1997--indicated that its yield increased by 5.1 percent compared with the previous first quarter. That resulted in a break-even load factor of 58.3, which American surpassed by a wide margin with a 67.3 percent load factor. Another significant contributing factor was a 21.1 percent drop in fuel prices, from 74.7 cents per gallon to 58.9.

"We had a very gratifying first quarter, during which strong demand, sensible pricing, modest industry capacity growth and favorable fuel prices created good business conditions for the company," said American's outgoing CEO Robert Crandall (see story, page 3).

These factors stem from conditions both within and beyond the airlines' control. In recent comments to the International Air Transport Association's financial management conference, Salomon Smith Barney airline analyst Julius Maldutis credited improved management, alliances, lower-cost distribution channels and capacity shortages for the airlines' success.

Eliminating money-losing operations, focusing on earnings per share and building up "virtually impenetrable" fortress hubs, Maldutis said, allowed airline managers to show they are no longer the aviation dogfighters of old. Many of those managers, he noted, came from outside the industry and spurred a "philosophical change."

In terms of capacity, Maldutis predicted a severe capacity shortage due to Stage III noise regulations set to be enforced next year, various airworthiness directives by the Federal Aviation Administration that will make some older planes less profitable and new emissions standards expected this year from the Environmental Protection Agency.

"This is not to say that some carriers do not have worrisome expansion plans, but the capacity shortage will continue for years to come," Maldutis said. "Barring any financial meltdowns, 1999 will be the sixth consecutive profitable year, although it may be flat."

The effect of capacity shortages is intensified in the face of projected increases in demand. According to FAAs traffic forecasts released last month, U.S. domestic travel will grow at 3.5 percent for the next 12 years (see chart). Commuter air carriers will see an even greater growth rate, 7.8 percent for this year and averaging 5.5 percent annually until 2009, FAA projected.

Overall U.S. commercial passenger enplanements, the agency said, are expected to grow from 595 million in 1997 to 924 million in 2009, making already tight seating even tighter. Systemwide load factors have increased from 62.9 percent in 1993 to an all-time high of 70.3 percent in 1997. That trend is exacerbated as carriers figure out new ways to fill in distressed inventory at the last minute, through e-mail, online auctions and other means.

FAA predicted the growth rate for international routes will top 5.8 percent, with the Atlantic averaging a 5 percent increase and the Pacific at 5 percent. Latin America, at 6.5 percent, will surpass Europe in total passengers by 2009. Total passenger traffic between the United States and the rest of the world will almost double over the next 12 years.

For foreign carriers, the picture may be a bit less rosy, but it still is pink. While world airline profits topped $5 billion in 1997, those same figures are expected to fall significantly this year because of the Asian economic crisis.

Even the U.S. carriers are not immune. "Asia is the number one issue here, although it continues to be 'okay,' " said Joe Laughlin, director of business markets for United Airlines. The carrier recently warned Wall Street about the impact of the crisis on its first quarter earnings, which were not yet released at press time.

United's Asian competitors, meanwhile, are wishing things were as good as "okay." According to IATA's director general, Pierre J. Jeaniot, "It is on Asia that our concerns are now focused. The suddenness and severity of the Asian economic crisis has taken most of us by surprise and, more particularly, the Asian carriers, which were somewhat ill-prepared for such a turn of events."

IATA has reduced its estimates for average growth rates in Asia between 1997 and 2001 from 7.7 percent to 4.4 percent--a total of 30 million passengers fewer. IATA estimated that the impact on profits for all carriers operating to, from and within Asia would exceed $2 billion in 1998.

Referring to the world airline industry as a whole, Jeaniot predicted a sharply reduced $3.9 billion in profits this year (following $5 billion in 1997). Traffic is expected to increase by 5 percent, with capacity up 6 percent. Last year, he said, carriers in the Americas made a net profit on international services of $2.5 billion on $38.1 billion in revenues; European, Middle Eastern and African carriers earned b$72.3 billion in revenues but only $2.2 billion in net earnings; and Asian carriers made only $300 million on revenues of $35.4 billion.