Low-Fare Airlines Hitting Some Rough Air

For five years, low-fare airlines have pummeled their larger competitors, forced down ticket prices and substantially reshaped the travel industry.

But today, with crushing fuel prices and the pressures of rapid growth and increasing competition, many analysts and industry insiders are wondering whether the low-fare engine has run out of steam.


Dallas-based Southwest Airlines, the nation's largest discount carrier, implemented its largest price increase ever this week, ending a $299 cap on one-way fares, in response to rising fuel costs.

JetBlue Airways, once the darling of Wall Street, posted a loss for the fourth quarter, and its stock (ticker: JBLU) has fallen 33 percent this year.

AirTran Airways also reported a small loss for the fourth quarter and has been cutting some unprofitable routes, including its Dallas/Fort Worth-Los Angeles flight.

Frontier Airlines is in the middle of a bruising battle between Southwest and United Airlines in Denver. That carrier's stock ( FRNT) is down 23 percent this year.

"The industry's biggest problems right now are at the low-fare carriers," said Mike Boyd, an airline consultant with the Boyd Group in Evergreen, Colo. "They're the ones who are vulnerable."

To be sure, the discount airlines continue to outperform the major hub airlines such as American Airlines of Fort Worth, which lost $861 million last year. Other carriers did even worse: Delta Air Lines lost $3.8 billion last year, including restructuring costs, and Northwest Airlines lost $2.6 billion.

But the traditional airlines are focused on restructuring, in some cases through bankruptcy. They've been cutting costs, jettisoning pensions, canceling airplane orders and working to boost revenue.

Wall Street has been bullish on some of the larger airlines. American, for example, has seen its stock ( AMR) rise nearly 21 percent this year. Shares of Houston-based Continental Airlines ( CAL) are up 22 percent for the year. United Airlines' shares ( UAUA) have risen 13 percent since it left bankruptcy in February.

The discount airlines, meanwhile, are struggling to stay on top. After several years of robust growth and strong financial performances, the low-fare airlines face their own cost pressures and operational problems.

"We're going through a rough patch right now," said David Neeleman, JetBlue's chief executive, at an aviation conference in New York this week.

Fares rising

Southwest and other discounters have had a strong effect on fares over the past five years. Since 2000, average domestic fares have dropped nearly 17 percent, from about $259 each way in 2000 to $216 in 2005, according to American Express Business Travel.

They hit a six-year low in mid-2005, according to the group. But prices edged up during the second half of the year, rising to $223 during the fourth quarter, according to the firm.

"As demand grows and capacity shrinks, the airlines have grown stricter on sticker prices," said Andy McGraw, senior vice president and general manager of American Express Business Travel North America.

That trend appears to have accelerated in 2006, led by Southwest. The carrier has twice raised fares since the year began. Each time, competitors quickly followed suit.

"For the last five years or so, we've all gotten used to what's basically been like a permanent fare sale," said Alan Sbarra, an analyst with Roach and Sbarra Airline Consulting. "But now we're clearly in a rising fare environment."

Neeleman has hinted that JetBlue will also raise prices. He told analysts in New York that he was looking for "a better mix of fares," which typically means higher prices in some markets.

He said the airline planned to slow its growth in cross-country and New York-to-Florida routes to cool off the competition.

"With less insane competition, we can get a better mix of fares and higher average fares," he said.

Although it's bad news for consumers, the rising ticket prices could help major carriers like American recover.

Airline "capacity restraint and Southwest's continued push for higher fares represent the two most unique components of the industry's continued return to profitability," said analyst Jamie Baker of JP Morgan Securities in a recent report to investors.

Fuel pressure

By far the most significant problem for the airlines over the past year has been the rising cost of jet fuel. But Southwest was largely immune from the fuel crisis; it used hedging contracts to lock in much of its fuel purchases at lower prices.

In 2005, for example, 85 percent of Southwest's fuel purchases were locked in at $26 a barrel. That meant Southwest could continue to afford to charge low fares and force its competitors to match the cheap prices.

Those contracts began to expire at year's end. This year, the airline will pay $37 per barrel for 70 percent of its jet fuel and market prices for the rest.

And the protection will continue to diminish over the next several years.

"That's a pretty stout hurdle to overcome," acknowledged Gary Kelly, the airline's chief executive, during a recent analyst conference in New York.

Kelly estimates that Southwest will pay $600 million more for fuel this year than in 2005.

"With fuel being where it is, it was inevitable that we were going to have to take some action," said Southwest spokesman Ed Stewart. "The hedges bought us some time, but they aren't helping us as much today."

'Rough spots'

The discount carriers face other challenges as well. Southwest faces rising labor costs and a shrinking number of markets for growth, said consultant Boyd.

That's why the airline chose to begin service in Denver, after years of declaring that the city's airport was too expensive for its low-cost business model, he said.

"There are a limited number of places you can hurl a 150-seat airplane," he said. "You can't go to Shreveport and you can't go to Shanghai, but you know what? That's where the future is."

That leaves raising fares as the only option, Boyd said.

"The low-fare airlines have low costs, but they also have weak revenue streams," he said. "There's a limited amount they can do."

JetBlue ran into problems when it began to fly new Embraer 190 airplanes. Difficulty adjusting to the new aircraft helped give the airline the worst on-time rate in the industry between November and January.

"We did have some rough spots, we overscheduled it, there were some issues with it," Neeleman said. "We didn't give ourselves some slack."

Analyst Baker said many investors have finally realized that JetBlue is not immune to the industry's problems.

"JetBlue appears to finally be acting like an airline, as opposed to the mythical uber-profit machine some may have believed it to be," he noted in a recent report.

But despite the turbulence, most analyst caution that it would be a mistake to underestimate the discounters' ability to recover.

"Some people are saying that the advantage has gone back to the major carriers, but I don't see that happening," Sbarra said.

He estimated that fares would need to increase as much as 40 percent before the large hub airlines become competitive. "I don't see fares going up that high, to be honest," he said.

Boyd said that Southwest, in particular, is too smart to be kept down for long. The airline's executives will likely adjust their business model and operations while leveraging their lean structure to keep pounding rivals.

"Never, ever, ever underestimate Southwest Airlines," he said. Chairman "Herb Kelleher might dress up in an Elvis suit, but he's got an AK-47 in his pocket. He's armed and dangerous."

Fort Worth Star Telegram

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