"Cost-Plagued Airlines Go Alarmist"

Thursday, August 7, 2003

Cost-Plagued Airlines Go Alarmist 
By Eric Gillin
The Street


To hear Northwest Airlines President Doug Steenland tell it, the airline
industry's recovery is a myth. 

"We don't see any end in sight. We don't see the light at the end of the
tunnel," he said Wednesday at a press conference launching its new
transatlantic service on Airbus 330 jets. 
 
Misery has company. Delta Air Lines CEO Leo Mullin said in June that
airlines were in for "another extremely tough year." 

But how much of the outlook is genuine, and how much is posturing? Both
airlines are battling with unionized pilots over cost cuts. 

"It's not in their best interests to come out and say life is wonderful,"
said Helane Becker, airline analyst at Benchmark, adding that the carrier
comments are based in the truth. "Northwest is in a tough position. They
have an open pilot contract, and their pilots are among the highest paid in
the industry. Delta's are the highest." 

Turnabout

The dreary forecasts may catch investors off-guard, if only because
just-released results for the second quarter and July have shown remarkable
postwar improvement, and companies have generally been more positive. On
Monday, when American Airlines parent AMR announced that it would not go
through with a planned sale of $250 million in convertible notes, the spin
it gave was that an offering was "at odds with the growing improvement of
the company." (It was also because the offering was poorly received.) 

Three weeks ago, not only did every single major airline top estimates, many
were boasting about profitable quarters, thanks in large part to government
reimbursements for security costs, and improved metrics such as load factor
and traffic. 

But in its second-quarter release, Northwest accentuated the negative, with
CEO Richard Anderson telling investors that even though the company posted a
profit of $227 million, or $2.45 a share, it wasn't "seeing meaningful
improvement in the underlying financial performance of the airline." He
added that without one-time items like the government aid, the company's
results were the second-worst in company history.

Delta, which posted a profit of $184 million, or $1.40 a share, including
government aid, downplayed the fact that yield, a key barometer of pricing
power, increased by 3.6%. "Delta must remain diligent in our efforts to
establish a viable revenue-to-cost relationship," said Mullin in the
release. "Delta still faces many challenges as we cautiously emerge from the
worst business cycle in our company's history." 

Cogito Dim Sum
 
In the end, there is truth on both sides of the argument. Analysts say the
business outlook is mixed and, as other carriers have suggested, there's a
very dim light at the end of the tunnel. After its second-quarter release,
Continental said advance bookings were showing positive improvement,
although yields were constrained. American Airlines said demand was
improving because of stronger summer demand, but nearly everyone agreed that
visibility was limited, especially with business travel, and that things
were improving slowly. 

"I think smart investors know there is some realism to what Northwest has
said about business being tough," said Prashanth Kuchibhotla, senior airline
analyst at Eclipse Advisors, an airline consulting firm. "But I think that's
also part of the negotiating process. Savvy institutional investors know
what the carrier is aiming for and that the unions have been intransigent." 

During the summer, airline business is strong because of increased leisure
demand. But as Becker points out, the real acid test for Northwest, Delta
and the rest of the industry will come after Labor Day, when this demand
tends to dry up. In September, business travel will have to pick up to
sustain a recovery; otherwise it's back to cutting costs to meet reduced
demand. Investors should take the CEO statements for what they are and look
for improvement to business travel and yields instead. 

"The second quarter was good because of government money, but otherwise it
was a terrible quarter, and April was a horrible month," said Becker, who
noted that business in June, July and August appears to be quite strong. "We
need to see what happens with business travel in September. I might take
what they're saying with a grain of salt. Everyone has an agenda." 

Airline stocks sank late Wednesday on the negative comments from Northwest,
but they were mixed Thursday. At midday, the Amex Airlines Index was up
0.6%, led higher by Delta, up 13 cents, or 1.2%, to $10.64, but weighed down
by Northwest, down 20 cents, or 2.4%, to $8.04. 

(Neither Kuchibhotla nor Becker have had banking or business relationships
with Northwest over the last 12 months.)


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