Tags: Airlines | Seat | Cuts | Economy

Airlines Risk Deeper Seat Cuts Amid U.S. Wealth ‘Destruction’

Monday, 15 August 2011 11:38 AM

U.S. airlines may have to cut back on flying as the slowing economy erodes their ability to boost fares while they struggle with higher costs for jet fuel.

That squeeze “calls for contraction,” said Hunter Keay, an analyst at New York-based Wolfe Trahan & Co. A benchmark of fuel-refining expenses rose to record highs last week, adding to pressure on carriers to match Delta Air Lines Inc. and Southwest Airlines Co. in paring current capacity or future growth.

Consumer confidence tumbled this month to the lowest since 1980, stoking concern that Americans will curb spending. That gauge of public sentiment on Aug. 12 followed record swings in U.S. stocks as the Standard & Poor’s 500 Index whipsawed to gains or losses of at least 4.4 percent for four straight days.

“I don’t think airlines should view that nervousness as short term,” Keay said in an interview. “If executives are going to go out and assume high fuel prices are here to stay, then they should assume that fear and destruction of consumer wealth are here indefinitely as well.”

Airlines have raised fares across most of their domestic networks at least eight times in 2011, and had projected that a recovering economy would allow more increases. Those expectations are crumbling after three failures in the industry’s last four attempts to ratchet up prices.

‘Very Clear’

“It’s very clear the economy is not recovering,” Southwest Chief Executive Officer Gary Kelly said in an interview. “Business travel, for one, won’t grow until the economy really does grow at a healthy rate.”

Business fliers are the most lucrative for the industry, because they typically buy the most-expensive, last-minute tickets. The peak period for leisure travel ends with the U.S. Labor Day holiday on Sept. 5.

“At some point, as companies look at a weak economy and weak consumer spending, they may pull back” on travel, said Philip Baggaley, an S&P debt analyst in New York. “It will be more difficult for the airlines to continue to raise prices.”

That shifts airlines’ focus to chopping expenses. They can save money with steps such as reducing flight frequencies, dropping some routes and substituting smaller planes for larger aircraft. All those moves reduce available seating capacity, measured by the number of seats flown a mile.

Investors soured on airlines even before the rout that erased $6.8 trillion in value from global equity markets from July 26 through Aug. 11. The Bloomberg U.S. Airlines Index entered a bear market last month by tumbling 20 percent from its 2011 high. Its 35 percent drop this year before today outstripped the S&P 500’s 6.3 percent decline.

Crack Spread

While crude oil settled Aug. 12 at $85.38 a barrel on the New York Mercantile Exchange, 25 percent off the 2011 high, not all airlines benefit. Jet fuel averaged $3.08 a gallon this year through last week, 45 percent more than a year earlier.

The pinch on airlines is worse when measured by the so- called crack spread between crude and heating oil. Many carriers use heating-oil futures to hedge their purchases of jet fuel, which doesn’t trade on the Nymex. The spread reached $37.45 a barrel on Aug. 10, the highest in 25 years of data compiled by Bloomberg, and has more than doubled this year.

Delta CEO Richard Anderson told employees last week they shouldn’t be “fooled” by crude’s retreat.

“The economy has many challenges, and we have no reason to think low fuel prices will stick,” he said. Atlanta-based Delta will pare capacity later this year as much as 5 percent, up from a planned 4 percent. Buyouts and early retirements this year helped the world’s second-largest airline eliminate more than 2,000 jobs, a spokesman, Eric Torbenson, said last month.

Southwest, United

Southwest, the biggest low-fare airline, trimmed capacity growth for 2011 to a range of 4 percent to 5 percent from as much as 6 percent. Seating on Dallas-based Southwest will be unchanged in 2012, and “possibly slightly down,” Kelly said.

United Continental Holdings Inc., the largest airline company, has said its 2011 available seating would be unchanged. American Airlines, No. 3 in the U.S., has trimmed 2011 growth plans three times, to a goal of 1.9 percent. More adjustments in early 2012 are likely, according to the unit of Fort Worth, Texas-based AMR Corp.

“Betting on discretionary travel is not a good bet right now,” said Robert Mann, a former executive at American who runs consultant R.W. Mann & Co. in Port Washington, New York. “It will come down to how corporate travel continues and how corporate profits look in the third quarter and fourth quarter.”

‘Capacity Dial’

Airlines are positioned to respond after slashing their flying amid the double whammy of record fuel prices in 2008 and business travel’s collapse in the recession, said John Heimlich, chief economist of the Air Transport Association, the industry’s Washington-based trade group.

“Ever since then, it’s been a pretty watchful eye on continual refinement of the capacity dial,” Heimlich said in an interview.

Airlines filled seats at rates running at or near company records through July. And demand is holding up at Hawaiian Holdings Inc.’s Hawaiian Airlines, according to CEO Mark Dunkerley.

“There’s clearly a view out there that the market contagion is going to spread into what people buy and how they go about their everyday lives,” Dunkerley said in an interview. “We’re certainly not seeing it.”

Bond investors aren’t that optimistic. Delta’s 9.5 percent bonds due in September 2014 plummeted to the lowest since July 2010, Bloomberg data show. AMR’s 6.25 percent convertible bonds maturing in October 2014 slid to the lowest on record, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Keay, the Wolfe Trahan analyst, said an industry retrenchment would be inevitable.

“Any capacity plan for 2012 is how much should be cut, not should it be cut,” he said. “All roads to success ultimately lead to capacity discipline.”

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U.S. airlines may have to cut back on flying as the slowing economy erodes their ability to boost fares while they struggle with higher costs for jet fuel.That squeeze calls for contraction, said Hunter Keay, an analyst at New York-based Wolfe Trahan Co. A benchmark of...
Monday, 15 August 2011 11:38 AM
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