Are airlines at last getting smart?

Third-quarter results from airlines suggest they've learned the harsh lessons of the past decade and are preparing for any storm.

By TheStreet Staff Oct 27, 2009 4:59PM

TheStreet.comAir travel © Christie & Cole/Corbis By Ted Reed, TheStreet.com

 

Third-quarter results painted an unfamiliar portrait of the airline industry: It looked smart.

 

The results showed the benefits of more than a year of reducing capacity, and of adding incremental fees that provided each of the three largest carriers with at least $1 billion annually in new revenue. The fees fundamentally altered a fare structure that had existed since stewardesses of long-defunct Pan Am served fine food on china plates at no extra charge. Airlines, it seemed, were one of the few industries that actually prepared for the recent recession.

 

Among the nine largest carriers, seven beat third-quarter estimates and, excluding items, six reported profits. That's not bad for consumer-sensitive companies attempting to fly through an economic slowdown.

 

Bing: More on Airline Earnings

 

However, it's important to remember that the minimal profits came in a quarter that is historically the industry's most profitable. Airlines make money in the second and third quarters, then spend down in the fourth and first.

 

Airline executives are not patting themselves on their backs. They realize the industry retains structural flaws that have resulted in a cumulative loss for investors since the Wright brothers first flew.

 

"All of us have done what was needed to do to get through this very difficult time," said US Airways CEO Doug Parker, speaking at the conclusion of the industry's final earnings call on Thursday. "You're not going to see any additional casualties. Those of us that are around have made it through a difficult time.

 

"But it's not over," Parker continued. "We've got to get this industry back to profitability. The standard can't just be survival. We passed that standard, but there's a higher standard: getting investors a return for their investment."

 

On the American Airlines call, CEO Gerard Arpey noted that the carrier has arranged about $5 billion of new financing in recent weeks. "These are good developments to protect all of our stakeholders, but we are under no illusions that this represents a long term solution for our business," Arpey said. "Ultimately success will be measured by our ability to drive profits."

 

Like American, most carriers raised capital during the quarter, another positive sign showing an industry that, having learned the harsh lessons of the past decade, is now conditioned to prepare in advance for whatever crisis may occur.

 

In the years following the Sept. 11 terrorist attacks, which contributed to a falloff in traffic that began early in 2001, airlines addressed their high costs through a series of bankruptcies, cutting both capacity and costs.

 

For decades, the airline industry had been a place where everybody -- aircraft makers, airports, consultants, employees, executives, investment bankers and other vendors -- got rich. Everybody, that is, except for investors. How can it be that airport bonds generally have high ratings, while junk ratings accrue to the airlines ensuring that the bonds get paid off?

 

Following the bankruptcies, airlines reported two consecutive years of profits, earning about $8.6 billion in 2006 and 2007. This was an immensely positive achievement only by the standards of an industry that preceded it with losses of $36 billion over five years, according to Air Transport Association figures.

 

The profits might have continued for a third year, were it not for an extraordinary run-up in fuel prices. The resulting losses totaled $9.5 billion in 2008, leading to the capacity cuts and new fees. And today, the industry seems prepared for the next crisis, which could well be a return of high fuel prices.

 

On the AirTran earnings call, CEO Bob Fornaro looked into the future -- after first recalling that in 2003, AirTran ordered new Boeing 737s, factoring in the assumption that within two or three years oil could rise to $50 a barrel. Now growth is on the back burner, even at onetime high-growth companies like AirTran and JetBlue.

 

"Higher oil prices will mean less capacity in the entire industry going forward," Fornaro said. "Business travel will be more expensive; so will leisure traffic. You have to adjust to a much different reality."

 

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