Airlines' Forecast a Little Less Cloudy; Revenue Showing Effects of Cost Cutting

The long-suffering airline industry appears poised to break a five-year earnings losing streak this year, but not before major carriers have to clean up the mess of last year's sky-high fuel prices.

AMR Corp., parent of American Airlines Inc., and Southwest Airlines Co. both report fourth-quarter earnings Wednesday. Houston-based Continental reports today.

Wall Street, as usual, remains less interested in expected losses by AMR and others and more interested in what's to come for carriers that are using revenue tailwinds to battle fuel cost headwinds.

Airline revenue is leaping, not in absolute terms but instead when measured across all the seat miles flown by airlines in recent months.

Chief among the factors behind the rise is how major carriers have cut domestic flying sharply, giving them much more pricing power to raise fares on the remaining seats.

"We think the focus for investors remains on the carriers' capacity outlook, especially in light of the recent surge in oil prices," analyst Michael Linenberg of Merrill Lynch said in a recent note to investors.

"We believe the stocks will react very favorably to any further capacity reduction or, in the case of the low-cost carriers, a slowdown in their growth."

Fort Worth-based American has trimmed 2.3 percent of its domestic flying in 2005 compared with 2004.

Competitors Northwest Airlines Inc. cut 1.7 percent of its domestic network in 2005 and United Airlines Inc. cut its North American capacity by 5.9 percent.

The shutdown of Independence Air and merger of US Airways Group and America West Airlines Inc. also pulled some excess flying from the skies, and more cuts are likely as the industry tries to balance demand with a supply of profitable seats instead of a glut of money-losing seats.

The worry, Ray Neidl of Calyon Securities in New York said in a recent note to investors, is that rising fares "will take them only so far before marginal traffic demand is driven away," suggesting the peak of the current passenger demand cycle may not be far away.

Robust revenue growth has lifted many airline stocks to new heights in the past quarter despite the sobering fuel bills.

"It is hard to believe that companies that at best are expected to make only marginal profitability are selling at such high prices, particularly in light of the many risks and uncertainties the industry still faces," Mr. Neidl said in his earnings forecast.

Other analysts think investors are missing some good news on the fuel front, even though airlines are paying almost as much for jet fuel as they are for salaries and benefits.

Crude oil prices are trending back toward $65 per barrel, but refined jet fuel prices are coming down from their post-hurricane highs, Jamie Baker of J.P. Morgan said in an earnings forecast. A lack of refining capacity - much of it damaged by hurricanes - had sent jet fuel prices much higher than crude oil in the early fall.

"Unfortunately, the market apparently believes that jet engines run on crude," he wrote. "They don't."

If jet fuel continues to drop or even settles in a lower range than in the last half of 2005, AMR should post its first profit since 2000 and be joined by Continental, which has lowered its costs and stands to benefit considerably from less industry capacity.

American has a mini-crisis on its hands to sort out with its unions, which are furious about the prospect of $20 million or more being paid out to top executives as part of a long-term incentive pay program that was triggered by AMR's recent rise. The carrier has still lost $7.5 billion since 2001.

Profits have never been the issue for Dallas-based Southwest, which will extend its consecutive annual profit streak to 32 when it reports this week.

The low-cost, low-fare carrier's bigger worry remains its increasing exposure to high jet fuel prices. It was protected from the costs for several years by shrewdly purchasing fuel on the futures market, a strategy called fuel hedging.

Those protections will gradually fade in coming years. Southwest chief executive Gary Kelly wants his carrier to reach pretax margins of 15 percent, but Southwest will have to find more revenue to combat its rising fuel burden, analysts say.



Airline Date Estimate

Continental Today -$109 million

AMR Corp. Wednesday -$396 million

Southwest Wednesday $95 million

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