For U.S. Airlines, a Rosier Outlook Than the Losses Suggest

All U.S. airlines except Southwest continue to lose money, sometimes to the tune of $100 million or more in a quarter. Between the recession, September 11, destructive price wars, and flagging demand, it has not been a good decade for domestic airlines. Four of the top seven domestic carriers are in—or recently emerged from—bankruptcy. Just as conditions turned towards the better, jet fuel prices shot through the roof. Most airlines hedge a portion of their fuel purchases, but some were unable, due to their already poor financial states. However, hedging can only do so much when fuel prices rise 87% in one year.

Unsurprisingly, there has been a lot of red ink in recent airline financial reports. American lost $93 million the first quarter of 2006. Continental lost $66 million, and Alaska Air $79 million. Even reliably profitable JetBlue lost money.

On top of this, Northwest and Delta are under bankruptcy protection and in the midst of labor negotiations to slash salaries and benefits. Delta is even relying on volunteer labor to clean aircraft.

Fasten Seatbelts for Turbulence Ahead?

But the skies are smoother than they seem. While losses are still large, they are not nearly as staggering as they were just a year ago. For example, American lost $162 million in the first quarter of 2005. In fact, most major airlines have narrowed their losses despite sky-high jet fuel. Many would actually be making a profit were it not for higher fuel costs.

Demand is growing, and revenues are growing with it. Business people and leisure travelers are back in the air again as the economy regains strength. Meanwhile, airlines have become more proactive in managing capacity. Underperforming routes are getting cut, while smaller planes are shifted to less populated routes. The result is heightened passenger growth, but low or stagnant capacity growth—load rates in February were up almost 6% over 2005. This summer's seasonal capacity growth will be much more restrained than what is usually seen over the busy air travel season. Capacity growth for most airlines will come in more profitable international routes, while domestic capacity is constrained.

Summer vacationers may struggle with overcrowded aircraft, and airlines are reaping the benefits. As demand returns, airlines have regained price control. Carriers do not have to resort to slashing prices or selling at a discount to online retailers to fill seats. Successful price increases have stuck several times in 2006, with the latest round occurring about two weeks ago. Low-fare airlines have successfully increased prices as well. Revenue per available domestic seat mile was up 12% year-over-year in February, and prices could be 15% higher this summer than last. Fare sales for summer travel will be few and far between.

It would be hard to find an industry with such a rosy outlook, while losing hundreds of millions of dollars per quarter. Many analysts are quite bullish on American despite its $93 million loss in the first quarter. As mentioned above, this narrows the $162 million deficit from a year ago, but that first-quarter 2005 loss was softened by a large one-time federal tax break. Considering it spent over $300 million more for fuel this year, American figures it has turned itself around by some $500 million. First-quarter traffic was up 2.1%, while capacity decreased 0.2%. Its load factor increased 1.8 points, to 77.2%, and revenue grew 12.5%, helped by multiple $5-10 increases to round-trip fares. The cost-cutting and efficiency measures that American implemented will continue and capacity reductions will persist, including the discontinuation of 27 aircraft in July.

Clear Skies to Come?

While the market indicators look positive, an era of airline profitability is not guaranteed. Legacy carriers continue to struggle under the weight of high labor costs and pension obligations, as do several regional partners (such as Delta's Comair). And while the caveat to profitability of "but for fuel costs" is a nice story, airlines are still losing substantial amounts of money. Poor financials have already restricted some carriers' abilities to hedge fuel costs.

Competition remains fierce in many markets and destructive price wars may still occur. Further domestic competition may enter the market in coming years if European Union and U.S. regulators pass the Open Skies initiative, a compact designed to liberalize trans-Atlantic routes and possibly give foreign airlines access to domestic U.S. routes. Restructuring and a bustling market have helped many airlines price more competitively, but possibly to the detriment of their brands. As consumer priorities shifted to price, airlines cut frequent-flier benefits and such services as in-flight meals, resulting in a marketplace where price is even more important and brand loyalty has eroded.

Fuel, of course, will remain a huge wild card.

A flight at 36,000 feet certainly gives new perspective to our view of the world. Mountain ranges are reduced to bumps, national boarders disappear, mighty rivers twist lazily far below, and the deserts and oceans appear impossibly vast. A view from above, like profit figures on an airline's financial report, simplifies reality. Look closer for a more detailed perspective and a richer outlook will emerge.