Trouble Dogs Airlines

Woe is the airline industry. Let us count the ways -- again.

In the last 24 hours, the price of crude oil has moved back above $48 a barrel; AMR ( AMR), parent of American Airlines has warned it will miss revenue expectations for the next quarter; industry data show August results are far worse than analysts expect; Wall Street continues to lower earnings estimates; and Merrill Lynch downgraded three airlines, telling investors industry financials are "decimated."

And all this applies to the third quarter, when the industry is supposed to perform well, thanks to the peak summer travel season.

A big factor in the weakness is that fuel costs remain out of control. Four weeks after warning that fuel costs would be higher than expected, American increased its third-quarter fuel estimate again, to $1.27 a gallon, in a filing with the Securities and Exchange Commission on Wednesday night.

This year, the world's largest airline said it will spend $1 billion more on fuel than last year and while the carrier has added $10 to round-trip tickets to help offset the expense, the move could be doomed -- dozens of attempts to implement a fuel surcharge already have failed.

Costs remain too high at a time when revenue is weakening. In the filing, American warned that revenue per available seat mile, or RASM, which is the amount of money the carrier generates for every mile it flies, will be down 2.5% to 3.5% over last year.

And American isn't alone -- according to just-released data from the Air Transport Association, industry RASM fell 3.7% during the month of August, well below analyst expectations. This year, several airlines also suffered because of no less than three hurricanes in the southeastern U.S.

With August traditionally a strong month for the airlines, the outlook is growing more bleak as airlines enter autumn, when losses mount and cash burn increases. Airlines continue to add flights and launch fare sales to fill planes -- bankrupt US Airways ( UAIRQ.OB) is selling Florida round trips for $98 -- which is causing RASM to fall.

And so, Merrill Lynch downgraded Continental Airlines ( CAL), AirTran Airways ( AAI) and Delta Air Lines ( DAL) to neutral from buy and other brokerages, including UBS, CSFB and Bear Stearns, slashed earnings estimates for the third quarter.

"The industry usually generates its best margins and builds cash for the approaching seasonally slower winter during the September quarter," said Merrill Lynch analyst Michael Linenberg. "That won't be the case this year as high oil prices ... and three major hurricanes have decimated the industry's financials." (Merrill Lynch does and seeks to do business with the companies covered in research reports.)

In reaction to the latest torrent of pessimism -- which has intensified after US Airways filed for bankruptcy two weeks ago -- the Amex Airline Index fell 1.8%, led by the network carriers. American fell 36 cents, or 4.1%, to $8.38, Continental fell 39 cents, or 4.1%, to $9.11 and Delta dropped 13 cents, or 3.5%, to $3.57.

For the network carriers, costs are too high and revenue so weak that analysts say airlines could be losing money every time they fly. While stocks have fallen fast, estimates for one of the industry's strongest quarters may still need to come down, given the severity of recent weakness. And this is before the arrival of the historically wintry fourth-quarter, one of the industry's weakest periods.

"Absent a banner September -- which few people, including ourselves, expect -- third-quarter industry revenues are likely about 1.5% to 2.5% lower than we -- and at least some other contributors to consensus -- previously expected, leading to a negative industry operating margin," said Robert Ashcroft, analyst at UBS. "Bear in mind, third quarter is one of the two seasonally better quarters." (UBS does and seeks to do business with the companies covered in research reports.)

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