Fuel prices threaten airlines

Airlines need to cut 20 percent of domestic flights, analysts say.

Chicago Tribune

CHICAGO — It is a thrill ride nobody wanted.

Just months after reporting their highest annual profits in eight years, U.S. airlines are in a nosedive that could leave some major carriers in bankruptcy.

Leaders at Chicago’s United Airlines and across the industry are scrambling to devise business models that will hold up to the stresses of $130 per barrel crude oil and a sluggish economy.

If the 10 largest U.S. airlines don’t boost revenues and restructure loans, their cumulative cash could shrink 62 percent to about $8.6 billion by year’s end, estimated Philip Baggaley, chief credit analyst at Standard Poor’s.

That’s not sufficient to cover one month’s expenses at the carriers, he said. “In other words, in this simplified example, the airlines, as a group, would be at risk of bankruptcy,” Baggaley wrote in a research report.

To gain pricing power in a fragmented, overserved industry, U.S. airlines need to cut as much as 20 percent of domestic flights, analysts said. That’s equivalent to grounding two major carriers.

It is uncharted territory; what American Airlines Chief Executive Gerard Arpey termed “an environment of continuous disruptive change” in a letter to employees last month.

It comes as United’s directors ponder one of the biggest strategic maneuvers in the carrier’s 77-year history: a high-risk merger with US Airways that could reap rewards if executives can steer clear of potentially ruinous labor showdowns.

United is also exploring a code-share partnership with Continental Airlines that would allow the carriers to sell tickets on each others’ flights. Such a virtual merger could lead to the full-fledged combination similar to the deal that Continental executives rejected last month, analysts say.

But there’s no guarantee either option will pan out, analysts warn.

Airline mergers are unwieldy and notoriously difficult to complete. Continental, meanwhile, has other suitors. The Houston-based carrier has also held talks with American Airlines and could opt to remain allied with its current marketing partners, Delta and Northwest Airlines, which are also merging, sources said.

Deciding on a course is not easy for executives at United or any other carrier, especially given the stakes involved and the volatility of the global fuel markets. Crude oil prices have doubled over the past year, rising about 15 percent in the past two weeks alone. “Fuel is astronomically expensive, to the point of pushing the industry past the point of economic viability,” said Henry Harteveldt, travel industry analyst with Forrester Research Inc.

“Change clearly needs to be made, and it’s going to have to come across a host of areas,” said Kathryn Mikells, United’s vice president for investor relations, who declined to discuss its negotiations with US Airways or Continental. “There isn’t a single silver bullet.”

A United-US Airways tie-up would bring about $1.5 billion in savings and new revenues to help offset the nearly $6 billion increase in fuel costs the two carriers could see this year, say people familiar with the discussions.

The resulting carrier would have a broad national network that would feed more passengers, particularly wealthier travelers in US Airways’ eastern seaboard strongholds, to United’s lucrative international routes, analysts said.

The carriers could also eliminate costs by paring operations at selected hubs where their networks overlap. Harteveldt sees US Airways operations at Philadelphia, Washington and Phoenix as prime candidates for cuts.

And the sell-off that has battered both airlines’ stocks could actually work to the advantage of investors in the merger. US Airways’ market capitalization has shrunk to just $718 million, the lowest among major carriers; United’s worth is $1.74 billion, down 61 percent since Jan. 1.

Given these depressed prices, any financial gains resulting from the tie-up would likely send shares soaring, providing larger returns than investors would have seen if the companies’ combined market value had been higher.

“The lower the range the stock goes, the better the future return,” said Roger King, airline analyst with CreditSights Inc.

But that only holds true for recent investors in the companies, he added. Any gains wouldn’t likely offset losses suffered by shareholders who have ridden United shares down from the $40-range to about $14.

People close to the airlines say that while they have made progress, a deal is not imminent. Issues that must still be resolved include who will run the combined airline and how the resulting carrier would be branded.