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July was a good month for the airline industry as travelers packed planes, lifting revenue to where it was just before the World Trade Center attacks almost two years ago.

But demand continued to be driven by low ticket prices, which means airlines don't make as much by flying more often -- and that could hamper a recovery.

Friday night,

Continental Airlines


released stellar results for July, reporting a systemwide load factor of 84.5%, meaning nearly 85% of its seats were filled by a paying passenger. The number is the highest in Continental history, topping the previous record -- 81% -- seen last month, and up 5 percentage points over July 2002.

Continental said July revenue per available seat mile, or RASM, was up between 4% and 6% over 2002, while capacity was down 0.7% -- both signs that summer demand has been strong. Even more impressive than the comparison to the weak 2002 result was that RASM was flat with 2001 levels, and a belief among analysts that the company turned a profit for the month. (American Airlines parent



revealed similar July results on Friday night.)

"Continental's break-even load factor was well below the company's actual systemwide load factor, which implies the company was profitable in July," said William Greene, analyst at Morgan Stanley, in a note. "The good news is that Continental's RASM is close to flat versus two years ago. The bad news is that yields are still down year-over-year."

Merrill Lynch analyst Michael Linenberg estimated that Continental could have generated $20 million in net profit during July. This week, as the rest of the airline industry releases July results, analysts expect announcements similar to Continental's. If the second-quarter trend is any indication, load factors will be moving higher, revenue will improve and capacity will remain constrained.

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But yields, or pricing power, remain weak. And without any improvement to yield, the industry recovery faces a major hurdle because demand for travel wanes in the fall, especially with the second anniversary of Sept. 11 looming. Given the recent warnings surrounding the potential for a hijacking, any change to the terror alert level, currently at elevated, might suppress demand.

"Notably lacking from our list of ingredients

for a recovery, unfortunately, is any improvement in core underlying demand for air travel, which in fact may have taken a slight step backward on news of possible hijack attempts this summer," said J.P. Morgan analyst Jamie Baker in a note.

Also this fall, the federal government will force airlines to once again charge up to $10 a trip in security fees, which will further suppress yields. To help boost revenue, airlines have raised ticket prices for leisure travelers on the back of strong summer demand, but once the fall comes, these prices could plummet to help keep load factors high.

And prices are already low. As research from Deutsche Bank shows, airlines are slashing high-margin business fares, while simultaneously raising leisure fares. That has the net effect of lowering prices overall. During the week of July 28, the average leisure fare was $126, up $23 from year-ago prices. Meanwhile, the average business fare was $680, down $41 from 2002 levels. The end result? Fares are flat and some analysts say the business travel recovery is tenuous at best.

We're "still searching diligently for evidence of biz-travel recovery or a return of long-awaited 'pricing power,'" said Baker. "Zero for two on both counts, but we haven't given up hope for 2004."

Some -- like Merrill's Linenberg -- believe that the flat yield seen by Continental in July is a sign that pricing power has reached a bottom. (Within the last 12 months, Merrill Lynch, J.P. Morgan and Morgan Stanley have received compensation for investment banking from Continental -- and said they expect to in the next three months as well.) In Linenberg's view, "yields may have stabilized, and in fact, are actually starting to grow again. This is something that we suggested back in the spring -- that the airline industry could start seeing the re-emergence of yield growth as early as the summer of 2003."

But even Linenberg has tempered this optimistic view, cautioning that year-over-year yield comparisons will be easy, especially in the fall and winter.

Meanwhile, airline stocks were weaker Monday morning, reflecting a huge loss at United parent



and news that AMR filed to sell $250 million in convertible notes. The Amex Airlines fell 2.2%, led lower by AMR, off 69 cents, or 7.7%, to $8.26, and Continental, off 95 cents, or 6.6%, to $13.50.