Fuel Costs Accelerate Risks to Airlines

Cash could shrink quickly for the top 10 carriers if efforts to boost revenue fail, making bankruptcy a greater threat.

Given these depressed prices, any financial gains resulting from the tie-up would likely send shares soaring, providing larger returns than investors would have seen if the companies' combined market value had been higher.

"The lower the range the stock goes, the better the future return," said Roger King, airline analyst with CreditSights Inc. But that only holds true for recent investors in the companies, he added. Any gains wouldn't likely offset losses suffered by shareholders who have ridden United shares down from the $40-range to $13.81, Friday's closing price.

People close to the airlines say that while they have made progress, a deal is not imminent. Issues that must still be resolved include who will run the combined airline and how the resulting carrier would be branded.

Then there's the threat that disgruntled workers will undermine or disrupt operations following a deal. United's unions oppose the merger, in part because they don't want to be drawn into the labor strife that has riven US Airways since its takeover by Phoenix-based America West three years ago.

Tensions among US Airways' east- and west-based pilots are so heightened that there are reports of pilots refusing to allow their counterparts from the rival faction to ride on the jump seats in their cockpits, a common courtesy among U.S. airlines that lets off-duty pilots get to their destinations quickly.

Such distractions are the last thing the management teams need to deal with in this environment, said Kevin Mitchell, chairman of the Business Travel Coalition, a Pennsylvania-based advocacy group for large corporate travel buyers.

"That's a huge risk: These management teams are off in a quagmire trying to pull this together while their competitors eat their lunch," he said.

\ Most in the red

None of the major American carriers are expected to earn a profit in 2008, except Southwest Airlines, which is expected to benefit from costly hedges against rising fuel costs.

United, American and Northwest Airlines have all renegotiated covenants that would likely cause them to default on loans later this year if cash flows continue to decline. United also renegotiated an agreement with its largest credit card processor.

Even Southwest last week mortgaged 21 aircraft to raise $600 million in cash, bolstering the $3 billion it already has on reserve. Southwest spokeswoman Brandy King said the Texas-based discounter decided to "take advantage of attractive financing" and said the cash would go to "general corporate use."

While Southwest adds to its network, every other major airline is planning big cuts in flying after the busy summer travel season. United already has identified 52 flights that will be cut and is studying its network for others as it plans to ground at least 30 planes and trim its domestic network by 9 percent during the fourth quarter. It could reduce flying further if fuel costs continue to rise, Mikells said.

The nation's second-largest carrier is looking at a host of other ways to trim costs and raise revenues. Those initiatives are being coordinated by a council of senior leaders established to streamline planning. As of July 1, United will end a long-standing policy of awarding at least 500 frequent flier miles to its Mileage Plus members, no matter how short the flight. And earlier this month, it started charging passengers $25 to check a second bag, a policy other airlines also have adopted.

The baggage fees alone should generate $1 billion in new revenue for the 10 largest US carriers this year, estimates AirlineForecasts LLC. But that isn't nearly enough to cover the $23 billion jump in fuel costs that they face this year if oil stays at current levels, according to the Virginia-based market research firm.

If oil prices don't drop, financial pressures will grow for airlines as the year progresses, analysts predict. "There is probably no more challenging time for them since Sept. 11 in terms of running their business," said Forrester's Harteveldt.

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