Markets & Finance

Brighter Skies for Airlines


If 2005 was the year of bankruptcy for U.S. airlines, then 2006 may be the year the skies finally clear for this perpetually beleaguered industry.

At one point during 2005, five of the 11 major U.S. carriers -- UAL Corp. (United Airlines, UAUA), US Airways Group (LCC), ATA Holdings, Delta Air Lines, and Northwest Airlines (NWACQ) -- were simultaneously operating under Chapter 11 protection. US Airways, United, and ATA have since emerged from bankruptcy. At the same time that these and other carriers have been restructuring, many industry fundamentals seem to be improving, and this could drive a sharp recovery and growth in industry revenues in 2006 and 2007 after five years of enormous losses.

It may be too soon to say that the industry is completely out of the woods, however, owing to high fuel prices, continued losses at many major carriers, and large restructuring charges likely at the two major carriers still in bankruptcy. Standard & Poor's believes improving industry fundamentals will lead to narrower losses in 2006, but still expects the U.S. airline industry to lose money for the sixth consecutive year.

AHEAD OF THE PACK. In 2005, seven of the 10 largest U.S. airlines lost money -- only Southwest (LUV), Alaska Air Group (ALK), and AirTran Holdings (AAI) turned a profit. We estimate that the 10 largest U.S. airlines lost a combined $27.2 billion in 2005, on revenues of $96.5 billion. This total includes a $21.2 billion loss at United -- by far the largest loss for a single carrier in U.S. airline history. These net loss figures include significant reorganization items for the carriers that were in bankruptcy. Of United's $21.2 billion loss, for example, all but $579 million consisted of reorganization items related to the bankruptcy. Excluding reorganization items, the top 10 U.S. carriers lost about $4.0 billion in 2005.

At this point, S&P projects a $3 billion loss for the top 10 U.S. carriers this year. A few carriers are expected to post profits in 2006: AirTran Holdings, Alaska Air Group, American Airlines (AMR), Continental Airlines (CAL), Southwest, and US Airways. However, profits at these airlines are likely to be more than offset by substantial losses and restructuring charges at Delta and Northwest.

Next year looks a lot brighter, as S&P sees the potential for the whole industry to return to profitability. S&P figures the top 10 U.S. carriers will post a $4 billion profit in 2007.

Our forecast reflects an expected modest increase in oil prices, to an average of $58 to $60 per barrel in 2006, from the average of $56.48 in 2005. We expect a slight moderation in 2007 to $55 to $58 per barrel. Of course, these forecasts are far from certain, and oil prices could easily continue the sharp run-up seen in the past few years due to geopolitical uncertainty and other factors.

TRAVEL BUG. In addition, our forecast includes our expectation that continued increases in average airfares and higher passenger-load factors will lead to higher industry revenues. Higher fuel prices should be partly offset by the use of more efficient fleets, as carriers have retired their oldest, most fuel-inefficient planes.

In addition, some of the financially stronger airlines are at least partly protected from price escalations by hedging contracts put in place when prices were lower. Even this, however, will not be nearly enough to fully protect them from rising jet-fuel costs. Moreover, many of the biggest airlines have poor or no hedging positions to offset high oil prices.

On a positive note, travel has rebounded in the past two years, owing in part to the stimulus of low fares, coupled with pent-up demand and a strong U.S. economy. S&P is forecasting a 5% increase in domestic airline traffic for 2006.

Domestic capacity, however, has fallen. Through March, 2006, domestic capacity was down 1.8%, from the year-ago period. S&P is forecasting flat capacity for 2006, as expected sharp capacity cuts by bankrupt Northwest and Delta are offset by increases at growing low-cost airlines, such as Southwest, JetBlue Airways (JBLU), and other carriers looking to capitalize on Delta's and Northwest's situation.

READY FOR TAKEOFF. With the increase in travel and the decline in capacity, the average domestic passenger-load factor through March, 2006, was 77.5%, an increase of 1.9 percentage points from 75.6% in the comparable year-earlier period.

In general, S&P feels that restrained industry capacity levels, a record percentage of seats filled on average, strong passenger demand, and rising prices should drive strong revenue growth in 2006 and 2007. While oil prices remain a significant worry, any stabilization or moderation in oil prices could lead to strong profit levels for the first time in many years for much of the industry.

S&P currently has a 5 STARS (strong buy) recommendation on American Airlines and Continental Airlines, and a 4 STARS (buy) ranking on AirTran Holdings, Alaska Air, Southwest, and US Airways. S&P has a 3 STARS (hold) opinion on JetBlue.


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