Could Airlines Wing Way to Profitability in 2006?

FORT WORTH -- The most remarkable news of 2006 might turn out to be that the long-beleaguered U.S. airline industry turns a profit -- or comes close.

For the first time in more than a decade, all four of the airlines' key economic drivers -- supply of airline seats, travel demand, operating costs and fares -- are moving in the right direction, at least from the perspective of the USA's airlines. As a result, a growing list of airline bulls says that 2006 should show vast improvement from a disastrous 2005 in which U.S. airlines collectively lost an estimated $10 billion.

For consumers, it means higher fares and fuller planes. But for the industry, relief is overdue after five miserable years of the worst downturn ever in commercial aviation. Even established skeptics such as analyst Vaughn Cordle of AirlineForecasts, agree that "the industry is on the cusp of a recovery" in 2006. And, he says, it could turn into a "major recovery" if oil prices fall further than expected.

Industrywide profit this year remains unlikely to a large extent because of continuing deep losses by Delta Air Lines and Northwest Airlines, both in Chapter 11 bankruptcy since September. But many on Wall Street say the profit outlook is good for money-making discount giant Southwest. Further, they say, some of the most troubled big carriers in the last few years stand a good shot of moving into the black.

In particular, American Airlines, the USA's largest carrier, and No. 5 Continental Airlines are both well-positioned for turnarounds. US Airways -- formed in September when America West acquired the old US Airways out of Chapter 11 bankruptcy and adopted its name -- could also turn a profit in 2006. No. 2 United is expected to emerge from Chapter 11 in the first quarter, but it's not expected to earn a profit before 2007.

JPMorgan's Jamie Baker is among the most bullish Wall Street analysts. A year ago, he and others fretted about a high-cost industry "not built for $40 oil." Now, with oil hovering above $60 a barrel, he believes the strongest carriers will be profitable. Baker says he is more optimistic about the industry's "near-term fundamental prospects ... than at any time this decade."

Analyst Robert Ashcroft, who left UBS last year but continues to track the airline industry, says, "It shouldn't be a surprise that we're getting a transition year. The surprise should be that it took so long to get here."

Still, Ashcroft tempers his optimism: "Every year since 9/11, we have been looking for a transition year, but something kept it from happening. SARS. War. The economy. Hurricanes. Oil prices. Now, it looks like this may finally be the year. But my fear is that we'll wake up tomorrow and find that it's yesterday all over again."

Veteran airline consultant Julius Maldutis puts it more succinctly. Airlines "have a disturbing knack for screwing it up," he says.

Some industry analysts have more modest expectations. John Heimlich, chief economist at the Air Transport Association, the industry's trade group, cautions that even under the rosiest 2006 scenario, the industry is "not out of the woods yet."

Fewer domestic seats

Last year, rising fuel prices and persistent low fares pushed the big network carriers into making the deep cuts in flying capacity they had long resisted. Many of the planes removed from the domestic market didn't go away. Carriers shifted them to international markets where fares and demand are stronger.

But in the domestic market, the number of airline seats for sale this month is down 5% from a year ago, according to a USA TODAY analysis of schedule data from Back Aviation Solutions. That's 128,000 seats per day that are no longer available for sale, and the constricted supply makes it easier for airlines to get a better price.

That drop in capacity, and a nearly 5% increase in passenger miles flown in 2005, pushed the percentage of seats filled to record levels in 2005.

Even now, in the slowest time of the year for air travel, almost eight out of 10 seats are filled with paying passengers. In effect, that means most planes on popular routes, and most prime-time flights, are flying full.

It also helps the carriers that a lot of the demand is coming from business travelers. Business fliers these days typically don't pay the kind of premium prices they did in the go-go days of the late 1990s. But they still are time{ndash}sensitive and willing to pay significantly more than price-sensitive leisure travelers.

"The corporate players that pulled their horns in on travel back in 2002 and 2003 are getting back out on the road pretty significantly," says David Cush, general sales manager at American, the world's largest carrier.

He estimates about a 10% increase in the annual growth in business travel at American in the last year. That reverses a trend in which corporate demand had fallen every year since the all-time peak in 2000.

Leisure travel demand also has continued to grow this year despite fare increases, Cush says.

Fuel costs pull profits down

Only the persistent high cost of fuel prevents the U.S. airline industry from being in the middle of its biggest profit cycle ever.

Since 2000, the ATA's Heimlich estimates U.S. carriers have cut more than $15 billion in annual non-fuel costs, and they aim to chop several billion dollars more.

It's been painful. More than 160,000 employees have lost their jobs during the period. Most other workers have seen their pay and benefits cut, and their work requirements increased. United and the old US Airways defaulted on their pension plans, and Northwest and Delta are candidates to do so this year.

But those sacrifices and savings have been overwhelmed by high fuel prices. In 2001, oil was slightly more than $30 a barrel. However, strong demand and tight capacity for refining and delivery had more than doubled oil prices even before Hurricanes Katrina and Rita struck the Gulf Coast last summer. The price of crude hit $69.91 a barrel on Aug. 30, the day after Katrina struck, according to the ATA.

In the following weeks, the cost of refining it into jet fuel soared to more than $30 a barrel, on top of the crude price. Airlines briefly paid more than $2.10 a gallon for jet fuel in October, vs. about 90 cents in October 2004.

Ironically, consultant Maldutis says, high fuel prices gave carriers an unexpected ability to push through a string of fare price increases last year.

For once, a traveling public that for years revolted at attempts to boost fares -- even by $5 -- seemed willing to accept several rounds of fare increases.

Revenue for each airline seat flown one mile -- a key financial indicator -- rose about 6% in 2005. The bullish Baker expects it to rise another 12% this year in domestic markets, and 7% overall.

Those big unit revenue gains of the fall caused airline stocks to surge. The Amex Airline Index increased 42.5% from Sept. 21 to Jan. 6. AMR, American's parent, saw its stock price increase 128% in that period, while Continental stock rose 122%.

Baker believes the nation's economy will continue growing at or near its current pace throughout the year. He expects there'll be more room to bump up fares without driving away customers.

Oil prices remain a factor

But other analysts' more restrained outlooks seem well-founded.

Jonathan Leak, an executive at World Fuel Services, a consulting firm that advises airlines and others on fuel buying and hedging strategies, says that unless some unforeseen major event or trend shift triggers a big reduction in worldwide oil demand, "oil prices in 2006 will be volatile" and react to "the headlines of the day."

The ATA's Heimlich expects airlines to pay an average of about $1.67 a gallon for jet fuel this year.

Yet, Baker and other bulls hold out some hope that the airlines will pay a little less. They expect greater benefits from the easing in crude prices and refining costs, and from restoration of production at hurricane-damaged facilities. That would mean carriers such as American and Continental that already have made big strides in reducing their non-fuel costs could earn more than a few pennies per share this year.

Baker recently raised his 2006 earnings estimate on American to $1.60 a share from 50 cents, and on Continental to $1.15 a share from 90 cents. His is a minority view. Yet, in a recent report, he suggested that his outlook might be too conservative.

Not every industry watcher sees a significant improvement this year.

Calyon Securities analyst Ray Neidl says the risk of additional airline bankruptcy filings has faded for now.

But "the market has overreacted" to positive developments in the industry, he says.

Despite an outlook that he agrees is improving rapidly, Heimlich still projects an industry loss of $1.5 billion to $2 billion for 2006.

"It's a bipolar world," he says. "Some carriers like Southwest will have nice profits. But others could lose a lot. It's hard to imagine 2006 not being the best year since 2000, but that could still mean an overall loss for the group."

Meanwhile, industry veterans such as Maldutis and Cordle, who have seen the airline industry quickly swing from good times to bad, worry that once prosperity returns, the big carriers will somehow manage to lose the financial discipline that they've learned the hard way.

"You watch," Cordle says. "The first thing these airlines will do when they get on the other side of bankruptcy will be to announce exciting new growth opportunities. We'll be off to the races again and headed for another restructuring."



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