A Revenue Refueling

A year ago, U.S. airlines were beaten down and losing billions of dollars. This year, most are posting record profits.

The reason for the turnaround, in a nutshell: revenue.

Ancillary fees such as bag charges and change fees, higher fares and more passengers have combined to boost the industry's results, even with higher costs.

The latest record-setters Thursday included Southwest Airlines Co., Alaska Air Group Inc. and JetBlue Airways Corp., all of which said their third-quarter earnings establish new highs for them, excluding special items.

United Airlines Inc. and Continental Airlines Inc., which merged Oct. 1 into United Continental Holdings Inc., combined for net income of $741 million in the third quarter, or $840 million excluding items.

As a group, the eight large carriers that have reported so far boasted net income of $1.87 billion in the three months ending Sept. 30. A year earlier, they lost $588 million.

Through nine months, the same carriers have earned $2.3 billion. Last year? A loss of $3.1 billion. That's a $5.4 billion turnaround from 2009.

"Oh, my," Southwest Airlines chairman and chief executive Gary Kelly told analysts Thursday, "what a difference a year makes."

Normally, such a boost in an industry's earnings is driven by a combination of cost cuts and revenue increases. That's not the case in 2010.

Airlines aggressively reduced their expenses and slashed their capacity and head counts beginning in 2008 as they struggled first with high fuel prices and then with a worsening economy.

With little more to cut in 2010, most airlines have seen their expenses creep upward.

With AirTran Holdings Inc. not reporting until this morning, the other eight largest carriers saw their operating costs climb $2.02 billion last quarter compared with third quarter 2009. Normally, that would be their explanation for mounting losses.

But the same carriers saw their operating revenue jump $4.95 billion year over year, led by United Continental's $1.6 billion increase and Delta Air Lines Inc.'s $1.4 billion climb in revenue.

Eight carriers post profits

As a result, each of the eight carriers has posted a third-quarter net profit, ranging from $59 million for JetBlue to $387 million for the former United Airlines. A year ago, only two were profitable - $15 million for JetBlue and $88 million for Alaska Air.

In its report Thursday to investors, Southwest said it earned $205 million, or 27 cents a share, on operating revenue of $3.19 billion. That compares with a $16 million loss, or 2 cents a share, on revenue of $2.67 billion in third-quarter 2009.

Excluding special items related to fuel hedging, the Dallas-based carrier earned $195 million, or 26 cents a share. That set a record for a third quarter and just topped analysts' consensus of 25 cents. Southwest shares closed at $13.62, up 46 cents, or 3.5 percent, in New York Stock Exchange trading.

Kelly said he was "extremely happy with where we are with these results. There are always challenges in this very difficult airline business, but I am just glad I'm at Southwest Airlines."

Kelly and chief financial officer Laura Wright said Southwest is still seeing year-over-year increases in unit revenue - more strength, in fact, than they would have expected going into the fourth quarter.

October bookings and unit revenue are strong, and there's no reason to believe that it won't continue after that, they indicated.

"It suggests that we're continuing to build momentum. ... But we're not seeing the levels of business traffic at Southwest that we had in '07 and '08," Kelly said.

"And certainly what I've heard from counterparts around the industry, no one is representing that their business travel has recovered to that level," Kelly said.

Jim Compton, United Continental's executive vice president and chief revenue officer, said his company is "cautiously optimistic about revenue trends heading into the fourth quarter. We think the trends that we've experienced this year are in line with our belief that this is going to be a long, slow recovery."

"We're seeing some recovery in fares, but the number of corporate travelers is still lower than we'd like it to be. However, several recent surveys indicate that corporate travel volumes will increase in 2011."

Boosting capacity?

A continuing worry for Wall Street is that airlines, emboldened by their higher passenger loads and climbing revenue, will be tempted to boost capacity by buying more airplanes or taking parked ones out of the desert.

Southwest raised some eyebrows Thursday when Wright said the carrier's capacity in available seat miles will be up 5.3 percent in the fourth quarter, 8 percent in first quarter 2011 and 5 percent in the second quarter.

But she and Kelly said much of that is simply not cutting flying when Southwest moves into the winter, as it did last year.

Southwest ended the quarter with 547 airplanes, a record. However, with aircraft being retired, it will drop to 546 by Dec. 31. Next year, it'll add 14 new airplanes and two leased ones, but retire 16 older airplanes, leaving 2011 capacity essentially flat with 2010.

Several analysts expressed disappointment that Fort Worth-based AMR Corp. said Wednesday that it will expand American Airlines Inc.'s capacity by 3.5 percent next year, faster than the gross domestic product is expected to grow. AMR reported third-quarter net income of $143 million.

"While insufficient, in our view, to single-handedly alter the otherwise still-encouraging industry dynamic, AMR does appear to pose a discipline 'challenge' to its peers," wrote analyst Jamie Baker of JP Morgan in a Wednesday evening report.

Analyst Gary Chase of Barclays Capital called AMR's capacity plans "the bad news of the day" on Wednesday.

"Other carriers are providing guidance in line with to lower than our assumptions," Chase said, "so the capacity outlook is still a good one."

AT A GLANCE Airlines' third-quarter profits

AMR

$143 million

Up $502 million from '09

Alaska

$122 million

Up $35 million from '09

Continental

$354 million

Up $372 million from '09

Delta

$363 million

Up $524 million from '09

JetBlue

$59 million

Up $44 million from '09

Southwest

$205 million

Up $221 million from '09

UAL

$387 million

Up $444 million from '09

US Airways

$240 million

Up $320 million from '09