Airlines Try to Learn From Past

Things are going well for the industry now, but plenty could still go wrong.
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A perfect mix of high demand for seats combined with low supply has transformed the once gloomy airline industry, where it now seems that nothing can possibly go wrong.

But can it? Throughout their history, airlines have failed to capitalize on such opportunities. Since the Wright Brothers' first flight in 1903, U.S. commercial airlines have posted a net loss of about $17 billion, according to the Air Transport Association. From 2001 through 2005, the industry lost $35 billion.

This year should mark a turnaround, with the ATA forecasting a net profit, excluding one-time charges, of at least $1 billion. But if the past is a guide, the future remains in doubt.

"We live in a very volatile industry," said Ed Bastian, chief financial officer of

Delta Air Lines

(DALRQ)

, in an interview. "We're subject to geopolitical risk, to a fuel spike, to whatever world events might come our way, and I'm not certain that

low fuel prices have any staying power.

"But the biggest risk to me, forgetting the geopolitical for the moment, is the

industry environment," Bastian said. "We've had capacity discipline for the last year that has bolstered our ability to price our product. I hope that we as an industry are able to maintain our discipline. There's always a temptation to fly more, to try to bring more capacity in. I think most of the industry gets that, but there's always a risk that somebody

won't."

In calling for capacity restraint, Bastian joins industry executives including Gerard Arpey, CEO of

AMR

(AMR)

, the parent of the world's biggest carrier American Airlines.

American has said it will cut overall capacity next year by 1%, with a larger decrease in domestic capacity. Delta, meanwhile, said last week that in 2006 its capacity will decline by 7%, with domestic capacity down by 14%.

Calyon Securities analyst Ray Neidl suggested in a recent report that industry discipline is holding, and he predicted an overall profit of $5.6 billion in 2007. Neidl said legacy carriers have cut back on growth, low-cost carriers have followed and "we believe further cuts

by low-cost carriers will be needed."

Benchmark Capital analyst Helene Becker said airlines are benefiting from a confluence of events -- fuel costs trending down, few aircraft on order, high loads that negate the necessity to reduce fares and an absence of open labor contracts. "It's not a perfect world," she said. "But if you put everything together, it's favorable. It's better than we've seen it for a while."

In the short term, oil prices will likely decline further, said Bart Melek, senior economist at BMO Nesbitt Burns in Toronto. "Supply is moving up, there is plenty of inventory around the world, even though OPEC is trying to cut output, and we will be having a slower economy over the next quarter or two," he said. Melek added that prices for a barrel of crude could fall into the mid-$50's over the next few weeks.

Consumer spending should also ease, Melek said. While GDP growth has slowed to a 1.6% annual rate, largely because of the decline in housing and construction, consumer spending "continues to chug along at 3.1%." The balance must be restored, he said. In the meantime, the impact of declining GDP has been mitigated because the oil price drop has freed up about $35 billion for spending.

Over the longer term, oil prices should rebound to above $60 in the latter half of 2007, as the economy picks up again, Melek said. And of course, they could go higher, given the geopolitical threats in Iran, Nigeria and elsewhere.

"If the president of Iran hugs Hugo Chavez on camera one more time, God knows what could happen with oil prices," said aviation consultant Mike Boyd. "Right now we've got about $10 to play with," he said, but broader increases could negatively impact airline results.

Service issues might also hurt the industry. So far this year, passenger load factors are historically high, while on-time arrival rates are historically low.

Airlines filled a relatively robust 80.4% of their seats in the first seven months of 2006, including 85.1% in July, according to the most recent available Bureau of Transportation Statistics data. Last year, occupancy averaged 77.6%, the highest annual average since World War II.

In the meantime, 76.5% of flights arrived on time during the 12 months ended Sept. 30, below the average on-time arrival rate of 78.6% over the 19 years since statistics were first kept, according to the Bureau of Transportation Statistics.

Loads approaching 80% are a big operational challenge, said Robert Mann, partially because anyone who misses a flight faces the probability that later flights will be fully booked.

"There is no margin for error. That's been a calculated risk," Mann said. But he noted that whenever airline executives pledge to reduce capacity, "they get a big thumbs-up from the street."