Airlines Taxi Toward Profitability

"The airlines have typically brought back capacity due to competition, not necessarily due to demand. That is, they're bringing back capacity to defend market share," said Sacks.

Indeed, major carriers must defend market share against low-cost expansion, creating some key battlegrounds in 2004. In Philadelphia, US Airways (UAIR) will now compete with Southwest. In Boston, both Delta and its low-cost Song unit will feel pressure from JetBlue. With carriers like AirTran expanding transcontinental service, competition will be fierce, and analysts have begun dropping estimates: On Dec. 9, Morgan Stanley analyst William Greene lowered his 2004 earnings outlook for the industry.

Furthermore, the big airlines may have cut costs in 2003, but the issue will continue to crop up in 2004. Labor costs are the single biggest expense for airlines.

While AMR and Continental have been able to negotiate wage concessions from unions, Northwest (NWAC) and Delta will be at the bargaining table in 2004. As it stands now, costs for the big carriers are still too high relative to the low-cost operators, and adding back too much capacity will exacerbate the problem because airlines will need to employ more people to fly more flights.

"Here's the risk with the higher-cost airlines: The people they're going to call back are the higher-cost people, causing some of those gains with cost cutting to go away," said Mike Lynch, managing partner of airline procurement at Eclipse, an industry consultant. "Right now, demand is getting close to supply, but drive that supply north and not only have you increased costs, you're right back where you were."

The Network Expansion Network carriers are ready to expand capacity in 2004, but profits won't come en masse until 2005
Carrier	2004 Capacity Growth* Estimate	2004 EPS Estimate	2005 Capacity Growth* Estimate	2005 EPS Estimate
American	+6%	-$0.13	+4.5%	$2.48
Continental	5.7	0.69	4	3.03
Delta	9	-2.63	4	2.06
Northwest	2	-1.29	2.5	2.48
* Morgan Stanley estimates; EPS estimates are from Thomson First Call Source: Thomson First Call, Morgan Stanley research

Fuel costs, which are the second-largest expense airlines have, will be another major cause for concern. Oil is still over $30 a barrel, and recent comments from OPEC indicate the price may stay that way for much of 2004. Because so many airlines have weak balance sheets, it's harder for them to hedge costs, leaving them at the mercy of the market.

The Bottom Line

Ultimately, analysts expect the major carriers to be able to counter the low-cost competition by selling more high-priced business-class seats. And while the industry will continue to grapple with costs and the supply-and-demand equation, comparisons in the first half of 2004 to results of the first half of 2003 are very favorable, so investors should look to buy sooner rather than later.

"The first half of the year, the majors will do better," said Prashanth Kuchibhotla, senior airline analyst at Eclipse. "The second half of the year will be telling."

	1.	SEC: Second Fiddle, Out of Tune
	2.	Airlines Taxi Toward Profitability
	3.	Markets Can Still Cash In on Government Help
	4.	Economy Sobers Up, but Hangover Lingers
	5.	Sound, Fury but No Inflation
	6.	Market Rally Still Has Legs
	7.	Asset Allocation Done Right
	8.	The Five Biggest Scandals of 2003

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