Airlines Brace for a Bumpy Ride

United Airlines' weak performance and a surge in oil prices leave stocks for U.S. carriers battered, just as Congress takes up industry consolidation

by Sonja Ryst

While 2007 is seen as a financially solid rebound year for U.S. airlines, a mix of events provided new evidence Jan. 23 of just how challenging the business remains. Shares in the sector suffered a good old-fashioned drubbing after United Airlines' parent, UAL Corp. (UAUA), reported a feeble fourth-quarter performance and crude oil prices staged a robust rally, gaining nearly 5%, to settle above $55 a barrel.

"There are so many reasons, and it's all ganging up to hurt them," says Jim Corridore, Standard & Poor's equity analyst covering the airline industry. (S&P, like BusinessWeek.com, is owned by The McGraw-Hill Cos.)

Atop that, a report in The Wall Street Journal suggested that Delta Air Lines' (DALR) creditors are becoming skeptical about US Airways' (LCC) hostile $10.1 billion proposal to acquire Delta out of bankruptcy court. The report, which cited "people familiar with the matter," said some of the creditors think any deal could be doomed by Delta executives' firm distaste for such a transaction. Likewise, Delta and officials at fellow Chapter 11 petitioner, Northwest Airlines (NWAC), have suspended negotiations about a possible combination, and no specific plans for further talks are in place, according to "people familiar with the thinking of both sides," the newspaper reported Jan. 23 (see BusinessWeek.com, 1/11/07, "Delta's Future Just Got Trickier").

Congressional Interest

As a result, the path toward industry consolidation appears to be longer than many investors may have thought—just as Congress prepares to formally weigh in on the issue. The Senate's Commerce, Science & Transportation committee is gathering testimony Jan. 24 on the effects of airline consolidation. Expect heavy doses of the oft-heard litany about why such combinations would strengthen the industry and how consumers benefit from financially sound airlines.

What'll likely prove more interesting is how stridently opposed—or accommodating—to consolidation the key legislative players signal themselves to be. Delta Chief Executive Gerald Grinstein and US Airways CEO Doug Parker are both expected to appear, along with officials from the Transportation Dept., the Consumer Federation of America, and the International Association of Machinists & Aerospace Workers.

Disappointing Quarter

Aside from the industry's configuration, there are operational hurdles to overcome. United, the nation's second-biggest airline in terms of revenue, lost $61 million (55¢ a share) in its latest quarter after two severe winter storms hammered its Denver hub, causing it to cancel 3,900 flights and sustain $40 million in lost revenue. Quarterly sales rose nearly 5%, to $4.59 billion, from $4.39 billion. Wall Street expected a per-share loss of 35¢ and revenue of $4.7 billion, according to Thomson Financial analyst data. On an operating basis, United earned $23 million, compared with a loss of $182 million a year ago, when it was still in bankruptcy. UAL shares tumbled 8.1%, to close at $44.81 on the Nasdaq.

It was also a rough day for investors at AMR Corp., the parent of American Airlines (AMR). That stock dropped 8.5%, to $36.70, after the company announced plans to raise about $500 million by issuing 13 million new shares. Capital from the new equity is to be deployed toward general corporate purposes, covering such things as employee pensions and American's need to upgrade much of its domestic fleet, staffed heavily by fuel-thirsty MD-80 jets. "The addition of equity sale proceeds would ordinarily be a credit positive, but industry consolidation opportunities could create a re-leveraging scenario," Kim Noland of Gimme Credit said in a note Jan. 23.

Perspective

The selling spread to Continental Airlines (CAL), which was off 5.5%, to $44.82, and to US Airways, which fell 6.6%, to $53.27. AirTran Holdings (AAI) fell 5.4%, to $11.13, and Jetblue Airways (JBLU) was off 2.5%, to $15.08.

Crude oil leaped 4.7% in New York trading Jan. 23, reaching $55.15 before settling at $55.04. The $2.48 jump was spurred by the Energy Dept.'s decision to boost the size of the Strategic Petroleum Reserve to 1.5 billion barrels this year, from 691 million barrels. The one-day gain was the biggest since September, 2005, according to The Associated Press.

Ray Neidl, an analyst at Calyon Securities, recommends keeping all the various risks in perspective. The U.S. economy and oil prices are "the two big things to keep my eye on as possible developments," Neidl says. "I think it's going to be a good year profit-wise" for most of these companies.

S&P's Corridore also thinks airlines will likely be able to benefit in 2007 from the recent cuts they made to their capacity last year, which should help to cap supply and press profits higher. And if jet fuel prices moderate further, airlines will reap additional profit margin gains, he says. He's estimating that airlines will enjoy healthy profits as long as oil stays below $58 a barrel. Adds Corridore: "The market is overreacting. If we see oil drop (Wednesday), they'll overreact the other way."

Ryst is a reporter for BusinessWeek.com in New York. With Justin Bachman in New York.