Airlines stressed by soaring oil

Analyst calls carriers, as a group, 'at risk of bankruptcy'

May 20, 2008|By Julie Johnsson | Julie Johnsson,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 nose dive 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 crude at $128 a barrel and a sluggish economy.

If the 10 largest U.S. airlines don't boost revenue 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 Friday.

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 other's flights. Such a virtual merger could lead to a 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."

None of the major American carriers are expected to earn a profit in 2008, except Southwest Airlines, which is expected to benefit from costly hedges against rising fuel costs.

United, American and Northwest airlines have all renegotiated covenants that would likely cause them to default on loans this year if cash flows continue to decline. United also renegotiated an agreement with its largest credit-card processor.

Even Southwest mortgaged 21 aircraft to raise $600 million in cash last week, bolstering the $3 billion it has on reserve. Southwest spokeswoman Brandy King said the Texas-based discounter decided to "take advantage of attractive financing" and said the cash would go to "general corporate use."

While Southwest adds to its network, every other major airline is planning big cuts in flying after the busy summer travel season. United already has identified 52 flights that will be cut and is studying its network for others as it plans to ground at least 30 planes and trim its domestic network by 9 percent during the fourth quarter. It could reduce flying further if fuel costs continue to rise, Mikells said.

The nation's second-largest carrier is looking at a host of other ways to trim costs and raise revenues. Those initiatives are being coordinated by a council of senior leaders established to streamline planning.

As of July 1, United will end a long-standing policy of awarding at least 500 frequent-flier miles to its Mileage Plus members, no matter how short the flight. And earlier this month, it started charging passengers $25 to check a second bag, a policy other airlines also have adopted.

If oil prices don't drop, financial pressures will grow for airlines as the year progresses, analysts predict.

"There is probably no more challenging time for them since Sept. 11 in terms of running their business," said Forrester's Harteveldt.

Julie Johnsson writes for the Chicago Tribune.

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