Northwest Airlines'

(NWAC)

ambitious and heretofore successful effort to reinvent itself for Wall Street has come to a screeching halt, thanks to the SARS virus.

The carrier, which had emerged this year as the main bull play in an industry littered with bankruptcy risks, has stumbled badly since the deadly virus gained worldwide fame. Since Friday, the shares are down about 6%, recently trading for $6.53. Over the same span the rest of the sector has rallied, with the Amex airline index up almost 11% on hopes for a federal bailout package.

SARS is a threat to any company doing business in Asia, but its timing is particularly regrettable to Northwest shareholders, who before it emerged had seen the stock rise 30% since Valentine's Day. The company is in the midst of a delicate and ambitious turnaround project, with plans to cut 4,900 jobs and slash capacity in a bid to reduce unit costs.

With a major hub in Tokyo and a significant chunk of revenue coming from Asian travel, Northwest is the U.S. carrier most likely to feel the impact of the skittishness SARS is causing. In the wake of

the San Jose scare, in which a Boeing 777 sat parked on the tarmac as three passengers were removed on fears they had the disease (they didn't), analysts have downgraded the company.

"Northwest has the largest exposure to the Pacific region of any U.S. airline, generating 26% of total capacity and 22% of total revenues there," said Jim Higgins, analyst at CSFB, in a research report. "The SARS issue is murky and serious enough that we believe a more conservative stance on Northwest shares is warranted, hence our downgrade."

Wounded Bulls

Northwest's advocates are led by Susan Donofrio, an analyst at Deutsche Bank, whose upgrade in late October laid the groundwork for the recent run-up. Three weeks into 2003, she lifted her 52-week price target on Northwest to $32 from $26, when the stock was at $6.79 a share. Deutsche has a banking relationship with Northwest and says it expects to receive or intends to seek business from the company in the next three months.

But the delicacy of the bull case was evident in some of Donofrio's arguments long before anyone heard of SARS. Where others saw a carrier that faces greater exposure to international markets and a workforce that is resistant to job cuts, Donofrio saw one with strong strategic partnerships, an older fleet that's mostly paid for, and a balance sheet that's better than those of its peers.

"Northwest's biggest strength is its liquidity position, which is currently at $2.2 billion in cash and equivalents, vs. $2.4 billion in the third quarter of 2002," said Donofrio, in a recent report. "With respect to pensions, Northwest needs $223 million to fund its plan in 2003."

Donofrio argued that Northwest's older fleet should mean it faces less exposure to the lease payments that rivals will need to pay out from an ever-shrinking stream of revenue. Based on figures from the end of 2001, Northwest owned 308 of the 442 planes it had at the time, according to her. "Over 60% of its fleet is over 20 years old and, presumably, paid for in full," she points out.

But that breaks both ways. Before the current downturn, Northwest had been trying to update its fleet, which with an average age of 15.1 years is the industry's oldest, according to Bear Stearns research. Furthermore, the company's total debt load more than doubled from $3.8 billion to $7 billion over the last two years.

Donofrio's assumptions that the company faces smaller lease and ownership payments is also a point of debate. The company didn't break out plane ownership in its most recent annual report. In the company's third-quarter conference call, CEO Richard Anderson said there are only a "couple hundred airplanes" in its 444-plane fleet that it doesn't pay notes on.

Just because it has the oldest fleet doesn't necessarily mean it owes less than rivals. According to Bear Stearns research from March, Northwest owns 56.3% of its fleet and leases the remaining 43.7%, which puts it in the middle of the pack, alongside rivals including

JetBlue

(JBLU) - Get Report

, whose average fleet age is just 1.3 years. The leader here would be

American Airlines

, a unit of

AMR

(AMR)

, which has an average fleet age of nearly 9 years, owns 75.7% of its fleet and leases just 24.3%.

Bad Timing

To all that, add SARS, which could seriously impede the company's plans to cut costs, since the previous cuts didn't factor in a massive downturn in Pacific travel. In mid-February, Northwest announced plans to drop its unit costs between 1 and 1.5 cents, which would put its unit costs between 8 and 8.5 cents, making it the one of the most efficient of the major carriers and make it even more competitive against low-cost rivals such as

Southwest

(LUV) - Get Report

, which has unit costs around 6 cents.

Northwest spokeswoman Mary Stanik said all of the company's flights to and from the U.S. and Asia go through Tokyo, where SARS has not become a major problem. Northwest wouldn't say if it plans to cut traffic even further or how much SARS could potentially affect earnings going forward, only that it is adhering to guidelines from the Centers for Disease Control when it comes to dealing with sick passengers and concerned employees. "We've cut no scheduled flights as a result of this issue. We're going to follow the CDC and do what they say," said Stanik.

More than any other U.S. airline, Northwest's short-term goals will be affected by the disease. If the disease can't be reined in, the carrier's plan to cut costs below other major airlines and use its strong balance sheet to ride out the economic storm will be all for naught.

SARS could force Northwest to cut even deeper than it originally planned. In slightly more than a month, SARS has spread quickly, with the World Health Organization saying it has afflicted 2,223 people in 22 countries, resulting in 78 deaths as of Wednesday -- up from 1,600 sick and fewer than 60 dead just two days ago. Hong Kong and China account for more than half of those afflicted, but with more than 70 cases confirmed in the U.S., no place is immune.

SARS may affect far fewer people than, say, pneumonia, but the fear is spreading faster than the disease. March traffic is already suffering because of it, with

Continental

(CAL) - Get Report

saying traffic across the Pacific was off 21.9% year-over-year during March and

American

saying Pacific traffic increased a paltry 10.9%, even though it is flying nearly 55% more flights than it did last year.

Even more telling, American said it filled 65.6% of its seats over the Pacific in March, way down from 91.4% a year earlier.