Stronger Headwinds for Airlines

S&P believes Katrina's effect on fuel prices is a more serious concern for carriers than the direct impact on their operations

Hurricane Katrina, which devastated parts of the Gulf Coast when it made landfall Aug. 29, will add to the problems facing the already hard-pressed U.S. airline industry. The most serious potential effect is higher fuel prices, rather than a direct hit on operations.

Loss of production from offshore oil rigs has reduced supply and boosted already high oil prices to around $70 a barrel. In addition, the closure of refineries in the Gulf area (representing 10% to 12% of U.S. capacity) is already raising gasoline prices significantly and is having an effect on jet fuel as well.

ONGOING REVENUE LOSS. Future prices will be affected by the extent of damage to refineries that produce jet fuel (most such Gulf Coast refineries are fortunately west of New Orleans), disruption of supply pipelines due to loss of electrical power or other causes, and the speed of repairs to facilities.

Direct effects of the storm include added costs to redeploy aircraft and some loss of revenue from flight cancellations. Widespread delays earlier this week should not cause large revenue loss, since passengers had already paid for flights that, in most cases, were eventually taken.

However, because parts of the Gulf Coast are likely to remain badly damaged for an extended period, airlines serving that region will see an ongoing loss of revenues. Although planes can be redeployed elsewhere, doing so adds capacity and creates the risk of lower fares in those markets.

DELTA BLUES. In the longer term, if the storm and resulting higher energy prices slow economic growth and consumer spending, that will have an indirect depressing effect on air travel. U.S. airlines have been able to implement a series of fare hikes in the domestic market since February, 2005. However, they may find it difficult to take such actions further, given that September is a seasonally weak period (with travel falling off after Labor Day). Now the storm may undermine demand even more.

Delta Air Lines (DAL ), rated CC and AirTran Holdings (AAI ), rated B-, have substantial operations in the Southeast. Delta is already bleeding cash and is at near-term risk of insolvency. The added financial pressure may hasten an already likely bankruptcy filing, which will probably occur within weeks.

AirTran, a midsize low-cost carrier based in Atlanta, has many flights in and out of the Southeast, but few directly to the affected area. It also has a more comfortable cash cushion and much better operating results than Delta.

CONTENDING WITH A STRIKE. FLYi (FLYI ), rated CC, is the parent of Independence Air, a low-cost airline based at Washington's Dulles International Airport, and, like Delta, it's at near-term risk of bankruptcy. Higher fuel prices and some flight disruption could hasten a Chapter 11 filing.

Northwest Airlines (NWAC ), rated CCC+, is contending with a mechanics' strike and losses due to surging fuel prices and high labor costs. Katrina has hurt its Memphis and Detroit hubs somewhat, but the indirect impact from fuel prices will be more significant.

Still, given Northwest's adequate near-term liquidity (unrestricted cash $2.1 billion at June 30, 2005), the outcome of labor negotiations with its various unions over the next six weeks remains the key issue in whether it can avoid bankruptcy.

READER COMMENTS

Baggaley is a credit analyst following the airline industry for Standard & Poor's Ratings Services

All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is or will be, directly or indirectly related to the specific recommendations or views expressed in this research report.
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