Eric Gillin

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Airlines See Steady October

Eric Gillin

Airlines filled more seats in October than they did a year ago, but fare prices were still cheap and demand was flat -- a reminder that the strong summer season is over.

Nonetheless, with shares steady after strong third-quarter earnings and with October results matching analyst expectations, stocks could be growing more attractive to investors who missed the rally.

Continental Airlines(CAL Quote), a bellwether for the rest of the network carriers, said traffic increased in October on the year, while revenue passenger miles, or traffic, grew 3.1% from last year, and capacity, or available seat miles, fell 3.3%. As a result, load factor for October, or the percentage of seats filled on every plane, hit 74% for the month, up from last year's 69.4%.

The carrier also said revenue per available seat mile, a key metric called RASM, increased between 3.5% and 4.5% over last year's RASM. While this means Continental is generating more revenue for every mile flown and indicates that metrics are moving in the right direction, analysts noted that yields continue to fall, which means pricing power remains weak and fare sales are driving some of the demand.

"Results confirm what we already knew. Summer is over. While in line with expectations, Continental's results certainly highlight the degree to which this remains a low-yield, traffic-driven recovery," said Jamie Baker, analyst at J.P. Morgan. "Until such time corporate travel budgets are reset -- obviously a year-end occurrence -- we do not anticipate anything other than anecdotal evidence of a business travel recovery."

Other Wall Street analysts backed up Baker's sentiments, telling investors that Continental's October performance was in line with fourth-quarter expectations. And other network carriers echoed Continental's results, using tight capacity controls to drive load factor increases.

American Airlines, a unit of AMR (AMR Quote), said traffic fell 1.7% on the year, marking the eighth-straight quarter of declining traffic. Nonetheless, load factors remain high, coming in at 70.2%, up 1.7 percentage points, because the company's traffic didn't fall as fast as capacity, which dropped 4.1% from last October.

"October's load factor at American was slightly better than our estimate for the [fourth-quarter] total," said William Greene, airline analyst at Morgan Stanley. "As we expect traffic trends to pick up in November and December, we see no reason to change our above-consensus estimate."

Low-cost carriers and regional carriers continue to outperform their network rivals, posting much larger traffic increases, even as they rapidly expand capacity.

On the low-cost front, Southwest Airlines (LUV Quote) said traffic increased 5% from last October, while capacity rose by 3.9%, driving load factor up 1.1 percentage points from last year to 63.6%. AirTran (AAI Quote) said traffic increased 33.6% and capacity grew by 21%, driving load factor up to 69.1% from the year-ago 62.6%.

Regional carriers continued to show explosive year-over-year growth, with ExpressJet (XJT Quote) announcing traffic increased 58.5% against a capacity increase of 43%, putting load factor at 70.3%, up 7 percentage points from last year. Mesa Airlines (MESA Quote) said October traffic rose 58.5%, with capacity up 39.9% and load factor coming in at 66.7%.

With these results largely expected by analysts, investors haven't been quick to snap up airline shares, some of which have quadrupled from their prewar March lows. Indeed, the rally in airline stocks appears to have stalled in recent weeks, as investors realize that the fourth quarter of 2003 and the first quarter of 2004 won't be nearly as profitable as the third quarter was.

On Tuesday, investors continued to sit on the sidelines and wait for better news, with most airline stocks posting small losses. The network airlines bucked the trend, with Continental gaining 12 cents, or 0.9%, to $13.63, while American rose 24 cents, or 1.3%, to $19.04. In the low-cost space, Southwest fell 13 cents, or 0.7%, to $18.72, while AirTran dropped 8 cents, or 0.5%, to $16.50. Among regionals, Mesa fell 7 cents, or 0.7%, to $10.43, while ExpressJet dropped 37 cents, or 2.4%, to $15.17.

As David Brine, airline analyst for Bear Stearns, noted, "for the airlines, in-line hasn't seemed to be enough for the market to get truly positive," arguing that when yields finally recover, airlines will have a great deal of leverage. And the economy set to improve, some analysts have been advocating buying shares into weakness to take advantage of the pending recovery.

"We believe that the recent round of profit taking is an opportunity to invest in a recovering industry," said Jeffrey Kauffman, airline analyst for Fulcrum Global Partners. "Many investors who have year-to-date gains in this space have been reassessing their holdings, in light of the performance year, which we believe has put pressure on shares."