The Airlines' Recovery Is Stalling

New traffic numbers show a reversal from the recent improvements, leading S&P to a neutral outlook for the industry

By Jim Corridore

Airline shares have been notably weaker in recent days as the latest monthly traffic reports come in. The group is down 8.8% this year through May 31, compared to a 5.9% decline for the S&P 1500 Super Composite index.

Indeed, the May reports indicate a recovery for airlines has been stalled. After traffic improved every month from October to March, it worsened in April and for the most part, the reports for May are coming in weaker than expected.

AMR (AMR ), parent of American Airlines, reported that revenue passenger miles (RPMs)-- a measure of traffic -- were down 11.1% in May. RPMs at United Airlines parent UAL (UAL ) fell 13.9%, and Continental's (CAL ) were down 8.3%. Southwest Airlines (LUV ) reported the smallest decline, 0.5%.


  America West (AWA ) reported that RPMs were up 0.3% in May, while Alaska Airlines (ALK ) saw a 1.7% increase in that traffic measure for the month. In the carriers' reports, load factors -- an important measure of the percentage of available seats filled -- improved on average, but were likely priced far below break-even. An attempt over the June 1-2 weekend to push up leisure fares -- the third such proposed hike in the last several weeks -- failed. Meanwhile, yields are expected to remain weak.

After the September 11 terrorist attacks, when all flights were grounded for several days, the airline industry received a $15 billion bailout package from the U.S. government. It consists of $5 billion in direct cash grants, along with $10 billion in loan guarantees, much of which is yet to be allocated.

Of the nine largest carriers, only America West has been granted a loan guarantee, for $380 million. U.S. Airways (U ) has applied for $1 billion in loan guarantees but hasn't yet received approval. United Airlines is also said to be considering applying for a loan guarantee.


  The government recently federalized airport security and hired about 28,000 workers in an effort to alleviate security concerns. The result: Airline travel has become less appealing amid new security requirements, frequent procedure changes, and a rush to get trained personnel in place.

S&P expects that with the exception of Southwest Airlines, which is likely to show a profit, the major airlines will show significant second-quarter losses.

Overall, S&P's investment outlook for the airline industry is neutral. Many carriers face sharp losses, and a few are at risk of bankruptcy in the wake of September 11. Passenger volumes are off sharply amid customer concerns about security, and in most cases the bailout package wasn't sufficient to cover losses incurred after the attacks.

Also, the industry is plagued by weak demand for business travel and by labor strife. Labor costs, which represent the airlines' largest expense, have been rising at the same time revenues have been dropping. Given the large unionized workforces at most airlines and the need for highly skilled personnel, this is a difficult category to cut costs from because carriers are unlikely to get concessions from the unions.


  A neutral stance reflects S&P's opinion that investment opportunities exist among the better-positioned carriers, which should be able to survive the current downturn and will be well-positioned for an industry rebound.

S&P has a 4 STARS (accumulate) recommendation on Southwest, Northwest Airlines (NWAC ), Continental, AirTran (AAI ), and Alaska Air Group. We think these companies are equipped to handle the current industry downturn and will benefit more than the rest of their peers when the turnaround occurs.

We currently have a 3 STARS (hold) ranking for AMR.

At the same time, we have a 2 STARS (avoid) recommendation on USAir and America West, two companies we feel are at risk of bankruptcy. And we recommend that investors sell (1 STAR) United Airlines due to its large losses, continued cash burn, high debt, management turmoil, and a limited likelihood of getting labor concessions.

Analyst Corridore follows airline stocks for Standard & Poor's

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