Airlines Yet to Climb out of 9/11 Woes

The U.S. airline industry was in serious trouble after the terrorist attacks of Sept. 11, 2001.

All flights were grounded that morning - and kept grounded for several days. Even after they returned to the skies, fewer people flew, and airline losses mounted.

A full five years later, the industry remains distressed.

Carriers fly over a greatly changed landscape, with most players battered and still trying to recover from the worst period in the history of commercial aviation.

Airline consultant Michael Boyd of Evergreen, Colo., says the industry has been changed forever by the events of 2001 and afterward.

"Right after 9/11, the shutdown damn near killed the airline business. The slowdown after that in revenue drained cash, and then add to that, in the last two years, fuel prices going up," Mr. Boyd said. "All those events basically ended up with airlines changing the way they do business."

As an example, airlines used to have "relatively good compensation" and good benefits, he said.

"Those days - at least for now - are over. You're dealing with a situation where the market cannot support the cost structure that was there before, and airlines have adjusted to that," said Mr. Boyd, president of the Boyd Group.

Not all the things that have happened to the airline industry since 2001 can be blamed on the events of 9/11. The industry peaked in 1998 and 1999, when U.S. carriers reported net income of $10.3 billion on revenue of more than $233 billion.

As the technology boom collapsed in 2000, industry profits dropped to $2.5 billion, less than half the $5.4 billion net income from 1999, even though revenue climbed to $131 billion from $119 billion.

"The downturn started in the spring of 2000," consultant Michael Roach said. "It started more than a year before 9/11. 9/11 was not the cause. Obviously, it was a horrible event and seriously exacerbated things. But the industry was well into a down cycle."

While the terrorist attack "made it the down cycle to end all down cycles," Mr. Roach said it would be a "huge mistake to say 9/11 caused the current industry distress or the current down cycle caused the industry distress."

Instead, he said, "it was caused by years of letting costs get out of control in the belief that higher revenues would surely save the day."

In fact, fares on an inflation-adjusted basis have been declining regularly since the 1920s, said Mr. Roach, a founder and partner in the San Francisco-based aviation consultancy of Roach and Sbarra.

For 2001, the U.S. industry piled up an $8.2 billion loss, eclipsing the record losses of $4.8 billion posted by airlines in 1992. Between Jan. 1, 2001, and Dec. 31, 2005, carriers as a group lost nearly $35 billion.

What has made the industry's current problems unique is the length and depth of the downturn. U.S. carriers as a group have lost money for five straight years.

Bankruptcy beckoned

The previous worst period, 1990-1993, coincided with the first Persian Gulf War, a slow economy and an airfare battle in 1992 that featured a half-price sale that ruined the summer travel season for airlines. The four-year loss totaled less than $13 billion.

The previous downturn caused a number of bankruptcies. The nation's fifth-largest carrier at the time, Continental Airlines Inc., survived, but several others, including aviation pioneers Pan American World Airways Inc. and Eastern Airlines Inc., never made it out of bankruptcy court.

But that round of failures was restricted to middle-tier or smaller carriers. In the latest downturn, the nation's biggest carriers were hit.

No. 2 United Airlines Inc., No. 3 Delta Air Lines Inc. and No. 4 Northwest Airlines Inc. all headed into bankruptcy court to reorganize their finances and slash their expenses.

No. 1 American avoided bankruptcy only through hard-nosed bargaining that won $1.6 billion in concessions from employees and hundreds of millions of dollars in cuts elsewhere.

"The big event, the combination of bad things - starting with the end of the dot-com boom and then the fuel costs - has really forced the industry to face up to the fact that its costs were out of control," Mr. Roach said.

The rapid rise in fuel costs has caused a cruel irony for carriers after they beat down their costs sharply in other areas. Had fuel prices stayed at 2002 levels, most carriers would be hugely profitable now. Instead, most are still trying to keep their heads above water.

As an example, American's revenue was $20.7 billion last year, $1 billion higher than in 2000, when it reported net income of $813 million. But American didn't make money in 2005, even with the higher revenue - instead, it lost $861 million.

Its operating costs other than fuel purchases totaled $15.2 billion in 2005, less than its nonfuel expenses of $15.8 billion five years earlier. The problem? Its fuel bill in 2005 reached $5.6 billion, up 125 percent compared with the $2.5 billion spent in 2000, even though its flying increased only 10 percent during the same period.

Southwest Airlines Co., whose costs in most areas were less than those of its larger rivals, used fuel hedging in particular to restrain its expenses. While its fuel costs rose two-thirds during the same period, up $538 million, its revenue increased even more, by $2.1 billion.

As a result, Southwest earned $2 billion in net income over the previous five years, compared with American's $8.1 billion in losses.

Although some have written off the so-called legacy carriers - the big airlines created before the industry was deregulated in 1978 - Mr. Boyd said that segment has the brightest future.

"They've shed their costs. They've shed a lot of the ways they've done business before. That means, going forward, they can start making operating profits at $65 a barrel [of oil], which is an achievement," Mr. Boyd said.

Mr. Boyd, who calls the old-line carriers such as American, United and Delta "comprehensive network carriers," said their networks will generate enormous revenue from small towns to big towns, from U.S. cities to international destinations.

Thinner bench

Newer carriers such as AirTran Holdings Inc., Frontier Airlines Inc. and JetBlue Airways Corp. are losing their lower-cost advantage over their older competitors, and they don't have the extensive international networks to garner as much revenue, he said. They're also facing more competition as they grow, with fewer markets to enter, he said.

"Between Southwest, JetBlue and AirTran, there are 250 more big airplanes on order, big being 100 seats and above," he said. "Now they're fighting with each other. Why is Southwest in Denver? Because they have to be."

The future is dimmest for regional carriers whose fleets are filled with small jets of 50 seats or less, Mr. Boyd said.

Mr. Roach said the industry's transition "is not over yet."

Delta and Northwest still haven't made it out of bankruptcy, and many experts believe the industry will consolidate further, he said.

Mr. Roach said the industry's fortunes seem to be on a slight upswing. But he finds it worrisome that most carriers haven't had a chance to reduce their debt.

"One could argue that they missed most of the current up-trend in the economy, which is starting to look a little long in the tooth," Mr. Roach said.

"They haven't built up their balance sheets the way they normally do in good times. They need a few more good years, and it's not looking clear that they'll be getting them."

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