Key questions: Competition could benefit travelers, but if a major carrier goes belly up, fares will rise. Atlanta Journal-Constitution Russell Grantham - Staff Sunday, January 2, 2005 For the airline business, 2005 is shaping up to be an "either/or" year. Either air travelers will get a late Christmas present --- extra seats and cheaper fares --- from carriers battling for East Coast markets. Or one of the nation's big hub-and-spoke carriers, crippled by years of heavy losses, could bite the dust, giving surviving airlines a chance to raise fares and recoup some of the $27 billion they've lost since 2001. Despite several waves of job cuts and turnaround efforts at most traditional airlines, including Delta Air Lines, Wall Street analysts estimate U.S. carriers lost well over $5 billion in 2004 because of high fuel costs and low fares. Meanwhile, most discount airlines continued to grow and make profits. Delta, which barely skirted bankruptcy this fall, will account for about 40 percent of the 2004 loss. Delta is expected to lose more than $700 million in 2005, even though its pilots agreed to $1 billion in concessions and it's in the process of cutting up to 6,900 jobs and other expenses to lop $5 billion from its operating budget by 2006. Airlines can't take such losses much longer without precipitating a major reshuffle in the industry, says Adam Pilarski, an economist with Avitas, an aviation consulting firm near Washington. Traditional airlines, he says, are in worse shape now than they were in the early 1990s, when recession and high fuel prices drove seven major carriers into Chapter 11 and two, Pan American and Eastern, out of business. "We have a worse situation but less suffering" so far, in terms of airlines going out of business, said Pilarski. "People have to remember that what markets do is kill companies that make bad decisions or run inefficiently." Some tremors could come as soon as next month, though Pilarski and other industry observers note that even the weakest carriers have been remarkably resilient. Washington-based Independence Air and US Airways --- the carrier is in its second restructuring under bankruptcy protection in two years --- both face key financial or labor concessions deadlines in January. US Airways' service disruptions during the Christmas holidays could cause travelers to scuttle to other carriers. United also remains in Chapter 11 limbo. Delta's Comair regional unit likewise handed travelers a Christmas nightmare when a computer glitch grounded all flights. And Delta could again face a serious cash crunch late next year if it can't get more relief from its underfunded pension plans and $20 billion debt load. Delta faces about $1.4 billion in debt and pension payments in 2005, estimated Kimberly Noland of Gimme Credit, a bond research firm. Unless there's a big drop in oil prices, "there is no cushion if the news is bad," she said. Of course, bad news for one carrier would be good news for the rest --- and bad news for bargain-hunting travelers. "The market will bring more discipline, and ticket prices will go up" if a major carrier ceases operations next year, Pilarski said. Overall traffic would be flat because of temporary disruptions in the affected cities, but the remaining airlines would be marginally profitable, he predicted. On the other hand, if no major carrier goes out of business next year, Pilarski expects the industry still will lose an additional $2 billion, despite booming traffic, nearly full planes and a wave of cost-cutting that has trimmed billions from most big hub-and-spoke carriers' budgets. So far, most Wall Street analysts' numbers match Pilarski's second scenario. They're projecting continued heavy losses in 2005, citing still-expensive jet fuel, low fares and continued growth of discount carriers. Oil prices a key Merrill Lynch analyst Michael Linenberg predicted 2005 will be a "profitless recovery" if oil prices hover around $40 a barrel. In a recent report, he wrote that industry consolidation is likely to speed up as strong airlines begin picking off weaker carriers or cherry-picking their assets. Delta and most other traditional carriers no longer have hedging contracts to buffer high fuel costs, their biggest expense after labor. Crude oil prices that peaked at more than $55 a barrel in 2004 added roughly $950 million to Delta's fuel bill, according to Noland at Gimme Credit. The price of crude, the main determinant of jet fuel prices, has since dropped to the low $40s --- still too high for many airlines to make money. The U.S. Energy Information Administration projects that crude oil prices will remain in the mid-$40 range in 2005. The cooling global economy and the repair of hurricane-damaged oil pipelines in the Gulf of Mexico will take a bit of pressure off oil prices, but inventories are lower than normal and production is already pegged at about 99 percent of global capacity, said the federal agency. Still, the high cost of fuel is only partly to blame for the industry's lack of recovery, Pilarski argues. The main culprit, he said, is chronically low fares stemming from the inability so far of traditional carriers in the United States to adjust to the rising power of discount carriers and bargain-hunting travelers after the industry's deregulation. Pilarski notes that the U.S. airline industry has lost about $27 billion since 2001, while the rest of the world's carriers are close to breaking even for the same period, even with similar fuel costs. For a variety of reasons, Pilarski said, U.S. airlines haven't been able to raise fares, shake off high costs fast enough or eliminate the least-efficient players. Many industry insiders now believe that's about to change, said Pilarski. At a recent industry conference, Pilarski said he asked how many in the audience of managers, investors and consultants expected a major airline to go out of business in 2005. "About 60 percent raised their hands," he said. Indeed, some analysts say Delta is positioning itself to survive and take advantage if a weaker carrier does cease operations next year. "They think they can hold on long enough until either US Airways or United drops," said James Parker, an analyst who follows discount carriers for Raymond James. "They're playing chicken." Changes at Delta As part of its turnaround plan announced this fall, Delta will shut its money-losing Dallas hub and rewrite half its flight schedule next month. Instead of shrinking capacity, as American and United are doing, Delta is shifting planes to Atlanta, Florida, New York and other markets. Delta expects other efficiency moves will bump up its capacity by the equivalent of 19 additional jets. Delta says the moves will allow it to concentrate on more profitable flying on international and domestic routes from its core markets, including its Atlanta hub. Delta's "Big Bang" --- that's what Chief Executive Gerald Grinstein dubbed the reworking of half the carrier's schedule, which takes effect late this month --- could very well be accompanied by a national rollout of cheaper, simpler fares to lure back discount airlines' fans, said Smith Barney analyst Daniel McKenzie in a recent report. Delta is plopping 42 percent more airplane seats in New York's John F. Kennedy Airport next year --- much of the extra capacity aimed at New York-based JetBlue. Delta also plans to add 27 percent more seats in its Salt Lake City hub, while its Atlanta and Cincinnati hubs get 9 percent to 10 percent more, said McKenzie. Delta is betting that simpler, cheaper fares and efficiency moves, like a smoother flight schedule at its Atlanta hub, will boost its traffic and its bottom line. Grinstein recently said Delta's "SimpliFares" test this fall at its Cincinnati hub, its second-largest, increased traffic by a third and business on its Web site by two-thirds. Some analysts say Delta's bet could backfire if fares in its core East Coast markets drop faster than its costs. AirTran, Southwest, JetBlue and other discount carriers plan to add 182 aircraft to their fleets in 2005 and 2006, noted McKenzie. All that extra capacity, along with still-high fuel prices, is a recipe for a tough 2005, he and other analysts said. "The terrible yield environment and high fuel costs that have caused recent operating results to be even worse than 2003 ... are unlikely to change," said Noland. Discount carriers "will continue to make market share inroads" in Delta's territory. "You have this war, essentially, that is going on with the legacy carriers trying to stop the low-cost carriers," said Parker, the analyst for Raymond James. "They're going to see low fares like they have right now because Delta is bringing more capacity. There's already too much capacity on the East Coast." Delta's strategy seems to be to retreat to "where their strength is," said Parker, and to hope weaker carriers like United, US Airways or Independence Air will expire soon enough to trim capacity and raise prices. Meanwhile, General Electric's financing arm has propped up several ailing carriers with recent cash infusions, including Delta, United, US Airways and Independence Air. "Something has to give," Parker said. "The question is, when? How long can the legacy carriers hold on before one of them shuts down?" DIVERGING COURSES Major hub-and-spoke airlines are likely to log more losses in 2005, despite job cuts. Meanwhile, analysts expect discount carriers to report bigger profits. NET INCOME/LOSS 2004-2005* (In $ millions) Major hub-and-spoke carriers ........................ 04............ 05 American.............. -$912.......... -$509 Continental............-$267.......... -$139 Delta................-$1,912.......... -$745 Northwest..............-$642.......... -$193 United.............. -$1,208.......... -$769 US Airways............ -$565.......... -$405 Discount carriers ........................ 04............ 05 Airtran.................. $6............ $25 Alaska Air................$4............ $55 America West............-$96............-$70 Independence Air...... -$156.......... -$150 Frontier................-$21............ -$5 JetBlue..................$39............ $44 Southwest.............. $334............$442 * 2005 numbers are estimates Sources: I/B/E/S and staff calculations / WALTER CUMMING / Staff __________________________________ Do you Yahoo!? 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