"Big Airlines Are Back"

Wednesday, March 28, 2007

Big Airlines Are Back
By Tom Van Riper
Forbes Magazine


A leaner Delta Air Lines is set to lead legacy carriers to a renewed round
of prosperity when it emerges from bankruptcy ahead of schedule next month.
That is, unless the economy slows substantially and oil prices spike by more
than a few dollars per barrel.

Industry experts are generally upbeat on the immediate futures of recently
troubled legacy carriers like Delta, UAL's United Airlines and AMR's
American Airlines, believing they have seen the worst and that cost-cutting
initiatives have industry balance sheets under control.

At an investor conference on Tuesday, Delta Chief Executive Gerald Grinstein
said his airline planned to emerge from bankruptcy protection by April 30, a
week earlier than originally planned. He also predicted 4% revenue growth
for 2007, to $816 million, based largely on a planned expansion into more
cash flow-friendly international routes, and the sale of some assets that
could include its discount arm Conair.

Delta eked out a $52 million profit in the September 2006 quarter, following
about $13 billion in losses during the previous two-and-a-half years. Its
stock, which nearly touched $80 a share in 1999, closed Tuesday at 67 cents,
shedding 8 cents in the last hour as oil prices (hence jet fuel) continued
to surge past $63 a barrel.

Delta's ability to get pilots onboard its cost program, while managing to
bring in non-union workers in every capacity except the dispatcher group, is
a big part of why costs are mostly under control, says industry consultant
Michael Boyd of the Boyd Consulting. 

At the same time, though, he figures Delta and other large carriers are
structurally set up to be profitable at $65-a-barrel oil and below. Most
have managed to turn operating profits over the past year as passenger
traffic increased. But with crude hovering above $63 a barrel, there's
little room for error.

"That's where it starts to get dicey," he says. "If Delta hadn't sold off
its fuel hedges for $80 million, they'd be sitting pretty."

And for an industry that tends to move cyclically with the economy, the
latest projections could bring some thin ice. Gross domestic product growth
slowed to just over 2% during the second half of 2006, following a robust
5.6% clip during the prior three months. Most economists are forecasting
similar modest growth for this year, though no less an authority than Alan
Greenspan placed the odds of a recession in the next year at one-in-three.
The March consumer confidence reading, meanwhile, checked in at a four-month
low, while the housing market continues to slump.

"Everyone is basically waiting for Delta and Northwest to come out of
bankruptcy, to see what the industry looks like and what the economy looks
like," says Ray Neidl, an airline analyst at Calyon Securities. He has
mostly turned bullish on the big carriers--provided the economy avoids
slipping into recession and oil prices don't push much higher--placing "buy"
recommendations on all non-bankrupt legacy carriers. That means all but
Delta and Northwest, which still require a wait-and-see approach.

Neidl is now less bullish on discount carriers Southwest and JetBlue, which,
despite their low fares and successful brand differentiations, don't figure
to stand up to large carriers' inherent strengths of international routes,
hub and spokes systems and frequent flier programs, not to mention their
improved financial health. Neidl is generally down on small regional
carriers like Frontier, which is getting squeezed in Denver between United
and Southwest. But he did save his top pick for Alaska Air, which grew
revenue 12% last year and which Wall St. predicts will grow earnings to
$4.77 a share this year from $3.45 in 2006.

Boyd cautioned against reading Delta's emphasis on expanding its
international business as a sign it will cut back on domestic routes,
arguing that more international flights enhances the domestic operation by
creating more demand to shuttle Europe-bound passengers to East Coast
airports like Atlanta and New York. That's another reason to be lukewarm on
the immediate earnings prospects for JetBlue and Southwest. Analysts say
they have too many airplanes without enough markets to fly them to. 

Don't count on Delta or other majors, even as they chase more overseas
routes, to cede any domestic business to the discounters.

Meanwhile, at the Delta investor conference, Grinstein downplayed the notion
that consolidation will play any real role in legacy carriers' return to
prominence, at least for a few years. A big guy might swallow up a small guy
here or there, but don't expect a merger between Northwest and Delta or any
other pair of large carriers, according to Grinstein.

Boyd, who thinks multiple airlines generally don't go well together,
couldn't agree more. So called synergies, he asserts, are terribly hard to
come by for airlines. Cost savings through scale are difficult when planes
are tied to separate maintenance schedules and pilots need to be taken out
of the productive loop for three months for retraining. 

"Only United and US Airways have even talked about it, everywhere else it's
pure rumor," Boyd says.

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