Prospect of fare war doesn't bode well
A big question is what impact the price changes will have on profits.
NEW YORK (AP) -- Moves by the major airlines to slash prices made headlines over the past week, but a potential fare war is just one of a multitude of pressures facing the industry.
Hefty fuel costs, challenging labor negotiations and mounting pension obligations add up to far bigger worries for airlines, especially the so-called legacy carriers -- Delta Air Lines Inc., UAL Corp.'s United, AMR Corp.'s American, Northwest Airlines Corp., Continental Airlines Inc. and US Airways Group. Financial professionals say it's a risky area to invest in, but if you've got the stomach for it, smaller low-cost carriers are probably the better gamble.
"Unless you are a highly risk tolerant investor, avoid airline stocks," said Brian Hayward, airline analyst at Zacks Investment Research in Chicago. "There will be trading opportunities. If you think you're good enough to trade on where oil is going to go, and you think you're nimble enough to trade on that information, good luck."
Long a cyclical industry, airlines have had trouble making money for decades, but were especially hard hit after the Sept. 11, 2001, terrorist attacks. Passenger counts finally climbed back to pre-Sept. 11 levels during the fourth quarter of 2004. But airline stocks have plunged since Jan. 1 amid weak earnings and word that Delta was cutting fares dramatically in an effort to lure back bargain-hunting business fliers.
The losses, as measured by the American Stock Exchange Airline Index (XAL), only deepened as competing carriers rushed to match Delta's price action, which cut the most expensive fares by up to half and eliminated Saturday night stay requirements. In the days after the news, the index sank 14.21 percent.
Delta's pricing action, a direct result of competition from successful low-cost carriers such as AirTran, JetBlue Airways Corp. and Southwest Airlines Inc., will likely accelerate industry restructuring, said Smith Barney analyst Daniel McKenzie. When it comes to determining which companies will survive, cash flow will be key, he said. "It is no coincidence we are seeing simplified pricing. It was inevitable for the industry, given the aggressive growth of low-cost carriers," McKenzie said.
"There's probably been no carrier that's struck as much terror in the corporate offices of airline history as much as JetBlue. That's what Delta has to respond to."
Hub fundamentals combined with cost structure will determine the long-term winners, McKenzie said. But in the short term, a big question for analysts is what impact the price changes will have on airline profits; it has not been factored into earnings estimates yet.
Fuel costs also remain a wild card. If crude oil prices soar back to the $55 range, it would increase bankruptcy risk for all the major airlines, McKenzie said.
As it is, Delta and American narrowly escaped filing for bankruptcy late last year, thanks to new financing and fresh labor concessions.
Currently in bankruptcy court are United and US Airways, which is just days away from the possible liquidation of its assets unless it receives concessions from its labor unions.
If one of the big carriers did go out of business, it would actually help the remaining airlines survive. If, for example, US Airways -- the seventh largest carrier with 6 percent of seating capacity -- is grounded by liquidation, it would create more business for East Coast competitors like Delta and AirTran, and the second-most vulnerable player, Independence Air, which is having trouble making jet lease payments. It also would create an opportunity for an up-and-comer like JetBlue to step into the lucrative Northeast shuttle market.
The problem is, when airlines run into trouble, they never seem to actually stop flying. This is in part because they employ huge numbers of people, which makes their demise political.
A more compelling reason, McKenzie and other experts say, is that companies that lease aircraft to the carriers are often lenient when it comes to deferment of debt, because they conclude the planes are worth more in the air than on the ground at a liquidation auction.
For the legacy airlines, although they've won concessions from workers, it's increasingly difficult to compete on cost with growth carriers like JetBlue or Southwest, which has the most consistent record of profitability in the industry. Because of this, analysts say, the low-cost carriers are better positioned to withstand all manner of pressure, whether it comes in the form of a price war or higher fuel costs.
McKenzie sees some buying opportunities for long-term investors who are prepared for a bumpy ride; Alaska Air Group Inc. is his top pick for the sector.
"If you are a bargain hunter, and can tolerate extreme risk or at least diversify it away in your portfolio, there are some airlines I think are long-term winners," McKenzie said. "I wouldn't fault investors with a longer time horizon in finding value in shares of Continental. And I also have a buy on AirTran, concluding that AirTran is a long-term winner in the industry and that it eventually will be valued as such."
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