Still Shaky, Even After The Shakeout

Ask most airline executives what they expect this year, and you'll get a weary shrug. "As every day goes by, you begin to wonder how good your numbers are," says John C. Pope, vice-chairman of United Airlines' parent UAL Corp. "You turn up your hands and say: `Who knows?"'

That's the question of the year for 1992. In the 18 months since the economy soured and the gulf war wreaked havoc on airline traffic, the industry has bled a frightful $4 billion-plus. Three major carriers--Eastern Air Lines, Pan Am, and Midway Airlines--have failed. Three others--Continental, TWA, and America West--are in default or bankruptcy. More than 57,000 people have been laid off. And airline shareholders have watched nearly $2 billion of their paper wealth evaporate in the stock market. Many analysts think the industry may actually turn a profit in 1992--if the economy resurfaces as early as the second quarter. But the carriers themselves don't seem to be betting on that.

"We see no prospect of a near-term recovery," says Donald J. Carty, executive vice-president for finance and planning of American Airlines' parent, AMR Corp. Says United's Pope: "Things were so bad it will take [the business] a long time to come back." United estimates that its 1991 loss topped $230 million, more than double its previous record loss. And Pope expects no letup in the first quarter. At USAir Group Inc., Chief Executive Seth E. Schofield puts his 1991 loss at $500 million. He isn't counting on profits again until 1993's second quarter.

Of course, the airlines will eventually rebound. Most experts argue that the recession and the war simply accelerated an industry shakeout that began with deregulation back in 1979. Now, they say, hard times are finally forcing out marginal players and excess capacity. As kamikaze discounters fail, the carriers that remain will absorb their traffic. Eventually, fares and profits will rise. "The rockier it gets"--and the more carriers that disappear--"the better it looks for the survivors," says analyst Timothy P. Pettee of Alliance Capital Management.

HEADWINDS. Wait a minute. Does it make sense to cheer for a continuing recession just to flush out weak airlines? Not everyone buys that argument. "I'm sure the carmakers figured they'd be in Fat City as soon as Packard and Studebaker got out of their way," says American's Carty. Indeed, the fascination with potential winners and losers obscures some important, longer-range consequences.

For one thing, even the winners will be scarred by the storm raging through the business. United, American, and Delta have incurred total estimated operating losses of $1.2 billion over the past two years--prompting American to cut $8 billion out of its five-year capital-spending plan. Meanwhile, the three have loaded up on debt. Add in off-balance-sheet airplane leases, and each has a debt-to-capitalization ratio topping 75%, figures Phillip Baggaley of Standard & Poor's Corp. That's up from about 65% in 1986, adding financing costs that hurt earnings.

Other expenses are piling up, too. Fuel prices are down--a major relief--but costs from maintenance to travel-agency commissions are rising fast for the Big Three carriers. Most troublesome are labor costs, an airline's biggest expense. In the past year, United, American, and Delta all succumbed to union demands and hiked their pilot rates to new highs. United's, for instance, will climb 30% over the next three years, its union calculates. Says American's Carty: "In this last set of contracts we didn't do an adequate job"--partly because pilots were threatening to strike.

Long term, the consequences of a shakeout will be sobering for customers, too. For all their balance-sheet excesses, low-cost airlines such as Continental and America West have kept the pressure on the likes of United, American, and Delta to keep fares down. Continental's uncharacteristic December initiative to raise prices $20 per round trip--a move quickly followed by the other majors--shows that fares will rise eventually to make room for profits. And as low-cost carriers fail, pressure to rein in expenses may ease, too. Says First Boston Inc. analyst Paul P. Karos: "It'll be real tough from now on to keep pressure on costs."

BANKING HARD. For its part, the financial community is doing its best to accelerate the shakeout. After years of easy money, distressed carriers can't raise a dime these days. And even likely survivors, such as USAir and Northwest, have seen the cost of their borrowings double recently. Compare that with the love affair between the capital markets and the strong carriers. United, American, Delta, and Southwest issued more than $8 billion in debt and equity during 1991.

This will let the big carriers grab even more turf. They are already sweeping into Europe and Latin America, using routes and planes bought from weaker airlines. And although expansion is another drag on earnings short term, international markets are where the best growth will be in the years ahead. With an entire country of travelers to draw on, United, American, and Delta eventually could make loads of money flying overseas.

For now, though, they're bracing for a cold, cold winter. Acknowledging as much, American in mid-December slashed some of its fares across the Atlantic to spur traffic. The storm may be abating for the airlines. But the winds haven't stopped blowing yet.