=20 ---------------------------------------------------------------------- This article was sent to you by someone who found it on SFGate. The original article can be found on SFGate.com here: http://www.sfgate.com/cgi-bin/article.cgi?file=3D/news/archive/2004/10/05/f= inancial1108EDT0081.DTL --------------------------------------------------------------------- Tuesday, October 5, 2004 (AP) Budget airlines seek 'bite' KEITH JOHNSON, The Wall Street Journal (10-05) 08:08 PDT (AP) -- LONDON -- A rift is opening in the booming discount-airline sector, with potential implications for shareholders in both no-frills carriers and in their old-line rivals. The sector has surged in recent years as budget airlines dumped most of the goodies long offered by traditional airlines, such as reserved seats, free meals and airport lounges. Now, some budget airlines are trading away part of their cost advantage over old-style carriers, adding some frills to lure higher-paying passengers. Within the low-fare club, a schism is emerging between airlines that pursue profits by relentlessly squeezing costs, and those wooed by the siren song of higher revenue. The two models are being thrown into contrast as oil prices continue to rise. Jet fuel, derived from oil, is usually an airline's second-highest cost, after labor. For short-haul budget carriers with lots of takeoffs and landings that guzzle fuel, the expense is even more significant. Industry analysts say airlines with the lowest cost base are best equipped to deal with prolonged high oil prices -- and investors appear to agree. Shares of budget-airline companies overall rose after the Sept. 11, 2001, terror attacks in the U.S. as traditional carriers struggled. But recently, shares in discount airlines have come back to earth. For now, with fuel prices high, shares of companies in the zero-frills club are outperforming those in the some-frills group. Shares in Southwest Airlines, the no-frills trailblazer, have slumped 12 percent on the New York Stock Exchange this year. But shares in rival JetBlue -- which pioneered "some-frills" budget aviation by offering inflight television, leather upholstery and service to big-city airports -- have fallen 19 percent on the Nasdaq Stock Market. The Dow Jones U.S. Airlines Index, which includes some traditional carriers, is down 22 percent for the year. Carriers with a competitive cost base have a long-term advantage in the industry because historically revenue per seat falls while costs creep upward. Carriers that sacrifice costs to chase more lucrative passengers "could end up in no-man's land," says Joe Gill, an analyst at Goodbody stockbrokers in Dublin, after hearing presentations from a variety of budget airlines around the world last week at an industry conference. With oil prices so high, he adds, "Costs become the crucible for these guys." Mr. Gill doesn't own any airline stocks. Revenue chasers, including JetBlue in the U.S., easyJet in Britain, Virg= in Blue in Australia and Air Arabia in the Middle East, argue that they will profit in the end. JetBlue, for example, is adding a fleet of smaller jets that will allow it to serve new regional markets. But the new fleet, from Brazil's Embraer, costs significantly more to operate than JetBlue's current Airbus fleet. "We believe there is a revenue premium we can achieve by operating that aircraft," says JetBlue Senior Vice President Tim Claydon. "It isn't about swallowing costs, it is about opening up a whole new market." Southwest's followers argue that approach is folly. "There is no point trying to grab an incremental revenue increase if it is going to cost you anything," says Tony Fernandes, chief executive of Malaysia-based Air Asia. The airline strenuously avoids adding costs. Managers wanted to serve Hong Kong, but balked at paying the airport's fees. So they fly instead to the cheaper airport in Macao and ferry passengers 45 minutes to Hong Kong. The revenue crowd says Air Asia's approach works in the tightest times, like now, but leaves money on the table if fliers start spending a bit more -- especially higher-paying business travelers, who increasingly fly budget carriers. Ray Webster, chief executive of London-based easyJet, says his airline benefits from serving Paris's convenient but expensive Orly Airport. "We think we can make an extra buck out of that market" by targeting time-sensitive business travelers. The airline is counting on new Airbus aircraft to help it lower operating costs and to offset pricier airports. For some investors, betting on higher revenue sounds all too familiar. Traditional U.S. carriers and old national airlines around the world posted windfall profits in the late 1990s by selling pricey tickets to business travelers, and didn't focus on controlling costs. When the business-travel boom ended in 2001, revenue plunged but costs remained high. The industry endured a spate of bankruptcy filings in the past three years as a result. In a head-to-head competition, says Michael O'Leary, chief executive of Ireland's Ryanair Holdings, low prices will always beat out "value" services. Ryanair, easyJet's larger rival and an early follower of Southwest and the sector's top penny-pincher, takes advantage of its lean cost base by aggressively cutting fares. Investors seem to concur with Mr. O'Leary. Shares in Ryanair and easyJet rocketed last year on investor excitement but have plunged this year amid profit warnings and falling ticket prices. Yet while Ryanair's shares are down 42 percent this year on Nasdaq, easyJet's shares in London hit their all-time low last month, and are down 55 percent for the year. Morgan Stanley's MSCI Europe Airlines Index, which includes only Ryanair from the budget sector, was down 17 percent through Sept. 27. Even some nimble European national carriers, such as Aer Lingus of Irela= nd and Iberia of Spain, are shaving costs to the level of easyJet. "Airlines like easyJet are like the ham, squeezed in the middle of the sandwich" between pure discounters and traditional airlines, says Iberia's chief financial officer Enrique Dupuy. "They can't compete on price unless they go hardcore, and they can't compete on equal terms for our business passengers." That is also a big problem for low-fare spinoffs of traditional U.S. carriers, observers say. Song, started by Delta Air Lines, and Ted, UAL Corp.'s addition to United Airlines, are trying to tap the budget market with frills similar to JetBlue's. But these spinoffs inherited many of their parents' costs, such as high pilot wages and big planes that were more costly to operate, says John Selvaggio, who stepped down last week as CEO of Song. "We can absorb that 30 percent extra cost as long as we fill the planes," he said. The problem: Filling the planes often means slashing fares, which cuts revenue. ---------------------------------------------------------------------- Copyright 2004 AP