Big cloud on airlines' 2012 horizon: Europe

Throw in high fuel prices, and the sector faces yet another tough year.

By InvestorPlace Dec 14, 2011 11:43AM
Brand X/JupiterimagesBy Susan J. Aluise

The airline industry has always been a notoriously difficult place to make money. Former American Airlines (AMR) Chairman and CEO Robert Crandall once characterized it as "a nasty, rotten business" that most resembles "the old game of Christians and lions."

So with European Union economies in disarray and fuel price volatility continuing to eat airlines' lunch, airlines face yet another treacherous year in 2012. Indeed, the worst-case scenario would be if the euro zone fiasco deteriorates into a full-blown banking crisis and European recession (with worldwide repercussions). If that happens, the global aviation industry could lose more than $8 billion next year, according to the international airline trade group IATA.

Even if EU leaders manage to head off a banking crisis, the IATA believes it's highly likely that Europe will suffer at least a brief recession. That's because business and consumer confidence have already fallen too far, and global GDP growth forecasts for 2012 have been revised downward to a mere 2.1%. That's awfully close to the danger zone: Whenever global GDP growth slips below 2%, the airline sector traditionally has lost money.

"The biggest risk facing airline profitability over the next year is the economic turmoil that would result from a failure of governments to resolve the euro zone sovereign debt crisis. Such an outcome could lead to losses of over $8 billion -- the largest since the 2008 financial crisis," said Tony Tyler, the IATA's director general and CEO.

As troublesome as those forecasts are for the industry in general, North American carriers like United Continental (UAL), US Airways (LCC), Delta (DAL) and Alaska Airlines (ALK) should fare somewhat better than their peers. The U.S. economy has grown at a faster pace than Europe's, and the airlines' capacity management moves have helped boost margins for most. Carriers that don't fly to Europe -- like Southwest (LUV), and JetBlue (JBLU) -- should have smaller potential downside from the EU mess.

American, which filed for bankruptcy protection on Nov. 30, will continue to struggle in the near term. In the wake of its Chapter 11 filing, the airline has endured stepped up safety inspections by the FAA, growing tensions with unions over pensions and other issues and even the scorn and mockery of Alec Baldwin, who was tossed off a flight last week after the actor refused to stop playing "Words With Friends" on his iPhone.

Although most U.S. airlines won't suffer the same hit next year as their European peers, the flight to profitability is still likely to be a turbulent one in 2012. Surging fuel prices in 2011 already will likely slash global airline profits by more than half -- from $15.8 billion in 2010 to a mere $6.9 billion projected for this year.

Oil prices over the past few weeks have topped $100 a barrel -- with Brent Crude, the usual measure for the airline industry, hitting more than $107 last week. Every dollar increase above $90 a barrel costs the global airline industry more than $1 billion in earnings. Since fuel now accounts for about 40% of airline expenses, any sustained support for oil prices above $100 in 2012 will hammer already razor-thin margins.

That's why airlines are scrambling to upgrade their fleets with more fuel-efficient aircraft. Southwest Airlines on Tuesday confirmed plans to order 150 of Boeing's (BA) re-engined, fuel-sipping 737 MAX jets as part of a record 208-plane deal. The airline is expected to take delivery  beginning in 2017. LUV will be the launch customer for the 737 MAX, which will sport fuel-efficient LEAP-X engines from CFM International, a joint venture between Safran and General Electric (GE). 

The new engines burn 16% less fuel  and are much quieter than traditional turbofan engines. The BA-LUV agreement comes on the heels of a similar fleet upgrade deal for American Airlines. United Continental reportedly also has been in talks about modernizing its fleet with as many as 200 new aircraft.

Potential new laws and regulations also pose a threat. U.S. Sen. Mary Landreiu (D-La.) introduced a bill last month that would require airlines to let passengers check one bag and bring one carry-on for free. She plans to introduce another bill that would impose fines on airlines that don't comply.

U.S. airlines would be forced to pay more than $3.1 billion in taxes between 2012 and 2020 if the EU emissions-trading tax is unilaterally applied to any carrier that files into a European airport. The tax is set to begin in January. The U.S. House of Representatives recently passed a bill prohibiting U.S. airlines from participating in the emissions scheme, but the vote was largely symbolic. Still, the House vote provoked the ire of  EU climate change commissioner Connie Hedegaard, who called it "arrogant and ignorant."

Regulators in the U.S. will have their hands in the airlines' pockets next year, too. Carriers will have to break down all ancillary fees such as checked bag or assigned seat charges -- a move that could cost each airline as much as $1 million a year.

And in January, new consumer protections require airlines to display all government taxes and fees in their prices; notify passengers of cancellations, diversions and delays of more than 30 minutes; and allow customers to cancel a flight without penalty within 24 hours of booking or seven days before departure.

Too bad airlines have no way of canceling any of the problems they face next year.

As of this writing, Susan J. Aluise did not hold a position in any of the stocks named here.


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