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Airline Profits: Take Off At Last

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Until recently, profits in the airline industry had been about as rare as a decent in-flight meal. Then, in late July, a bunch of carriers, including the parent company of American Airlines Inc., announced that they had made money during the second quarter--some for the first time in two years. The good news took Wall Street by surprise and has started talk that the industry is reviving. And with fuel costs down, labor willing to exchange wage cuts for equity, and fares finally rising, the optimism seems warranted.

The key question: How long can the airlines stay on an updraft? The major carriers are still saddled with costly labor contracts and inefficient route systems that make it nearly impossible to compete with low-cost upstarts such as Southwest Airlines Co. And fare stability in an industry where ailing companies need quick infusions of cash is anything but guaranteed. Profits of $47 million by American, $7.1 million by Delta Air Lines, and $5.8 million by USAir Group Inc. may look swell compared with last year's stunning losses. But notes American Chief Financial Officer Michael J. Durham: "It's hardly the mother lode when you have $20 billion in assets deployed to earn that."

"PATHETIC." Worse, even today's skimpy profits may not be sustainable. The improvement comes mainly from higher fares and plunging costs. Cost-cutting helped lower unit costs during the quarter by 1.5% at American and 2.4% at Delta, where a work-force reduction of 7,000 since last year has chopped $265 million out of overhead. Meanwhile, yields, the amount a passenger pays to fly a mile, jumped 10.8% at American as fares stabilized and then rose slightly compared with last year. Growth in domestic business travel also helped.

The problem: What's needed for continued gains is lots more passengers. And with the leisure market still very soft, says Peter M. Sontag, chief executive officer of agency USTravel Inc., the carriers can't raise prices. Fares are up, but only as compared with a terrible 1992. Since January, says airfare auditor Topaz Enterprises Inc., the average fare has fallen $57, to $535 in June (chart).

Another worry is that second-quarter results were dressed up by a fair amount of financial legerdemain. USAir's skimpy profit, for instance, included $18 million in additional income generated after the company reversed an earlier write-down on retired aircraft. Similarly, Delta's decision to depreciate aircraft over a longer period of time--to 20 years, from 15--added $34 million to its bottom line. Debt ratings give a truer picture of the carriers' financial health: The huge losses of the past three years have driven the ratings on the debt of the Big Three carriers (American, United, and Delta) down to junk-bond levels.

FAILURE OF WILL? Meanwhile, Southwest and America West Airlines Inc., and scrappy new entrants such as Kiwi, Reno, and Morris Air are prowling for more passengers. In mid-July, Southwest announced it would begin flying to the East Coast for the first time, initiating service from Baltimore--giving it a shot at the lucrative Washington market. New York could be next. "Competing with Southwest is a huge problem that's only getting bigger," frets a top Big Three executive.

Worst of all, profits, even paltry ones, could undermine the new detente between management and labor. At Trans World Airlines Inc. and Northwest, financial trouble inspired labor to swap wage cuts for equity. It looks like that trend might continue at United and American. But Durham worries that rising earnings could undermine labor cooperation. Indeed, after hearing about American's profits, the Association of Professional Flight Attendants repeated its intent to win "industry-leading" wages in current contract negotiations.

To be sure, there are some bright spots on the horizon. The industry will get some help from Washington, though not much. President Clinton's Commission to Ensure a Strong & Competitive Airline Industry has just released preliminary recommendations that urge Congress to lower the airline-ticket tax from 10% to 8%, a move that would net the industry up to $1 billion annually, and to exempt the airlines from any new gasoline tax. Northwest Airlines Inc. Chief Executive John H. Dasburg also figures that a recovering economy will lead to an increase in air travel and "the industry will become profitable."

But few believe this will offset the need for more restructuring. "This industry still needs to make fundamental changes," warns former Federal Aviation Administration General Counsel Kenneth Quinn. The industry's big fear: that euphoria generated by its paltry profits may undermine the will needed to make that happen.Kevin Kelly in Chicago, with Seth Payne in Washington

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