Low-Fare Airlines Hitting Some Rough Air

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.

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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