If the world economy is going to be smaller going forward, the U.S. airline industry was ahead of the curve.
Carriers have downsized dramatically since the summer travel season ended, preparing for a world of $140-a-barrel oil. They have eliminated older aircraft and marginal routes that account for about 10% of nationwide capacity, and they have implemented fees that are expected to add hundreds of millions in annual revenue for the major carriers.
Since then, oil prices have fallen steeply, setting the stage for what many people see as a profitable 2009. The wild card is whether the financial market turmoil will impact demand, but so far industry cuts appears to have offset any impact from a potential decline in travel.
With airline earnings reports set to begin this week, observers will be closely watching for news on future booking trends.
AMR and Delta will report on Wednesday, while Continental and Southwest will report on Thursday.
At US Airways, “bookings remain solid and we’re not having any trouble filling up airlines,” CEO Doug Parker said in a recent interview. “But you can’t help but be concerned.”
UAL, the parent of United Airlines, moved to cut fall and winter capacity, a decision that was “very timely, largely driven by high oil prices but just before the [financial] crisis had arrived,” CEO Glenn Tilton told ATW Online last week. United cut capacity by 16%.
Tilton said United has not seen any significant drop in passengers during the current quarter, although there is “some softening” in forward bookings for next year.
Without question, some airlines will pay a price for fuel-hedging bets they made when oil traded at higher prices. Last month, United said its third-quarter earnings will include $544 million in losses from fuel-hedging contracts. Alaska Air said last week that it expects a “significant” third-quarter loss due to special items including a $220 million mark-to-market loss on fuel hedges.
Still, as American CEO Gerard Arpey said in July during a third-quarter earnings call, falling oil prices “would be a high-class problem to have.”
Parker, meanwhile, notes that passengers are less likely to check luggage or consume drinks when a charge is involved. For instance, in September, the number of checked bags on US Airways fell by 25%. “We’ve stumbled onto a better product,” he says.
Many airline analysts are optimistic about 2009. In a recent report, Avondale Partners analyst Bob McAdoo writes that investors worry that demand is slowing, but he says the double-digit capacity cuts should more than cover any shortfall.
“Based on recent conversations with various airline management teams, we believe the sharp stock market selloff and current overall economic weakness are not materially slowing demand for air travel,” McAdoo wrote last week. “New bookings in the past seven days are neither meaningfully different than in recent weeks nor different from booking patterns last year.”
Standard and Poor’s analyst Jim Corridore has doubts. He recently reiterated a hold on American, raising his 12-month-target price to $8 from $6. “For ’09, we think the recent sharp drop in oil prices will lead to significantly lower losses than we were earlier expecting, although we remain wary of the impact of the global financial crisis on air travel demand next year,” Corridore wrote.
However, JP Morgan analyst Jamie Baker wrote in a recent report that even were demand to fall considerable, “we are having a tough time modeling losses.” Baker said airline shares are trading far below their value, saying: “Nothing we’ve experienced comes close to explaining a recent $5 share price for United, considering we expect it to earn something similar (untaxed) in 2009.” JP Morgan has a financial relationship with United that includes acting as a market maker.