Gray Skies Ahead -- But More Will Fly

-- Steep oil prices and overcapacity will keep bogging down airlines -- Travel is on the rise, perking up profits of hotels and car-rental companies

What a rotten year. Only Southwest, among the nation's top 10 airlines, earned a profit, while ATA and USAir joined United in Chapter 11 bankruptcy. Meantime, pilots at Delta, Northwest (NWAC ), and USAir were arm-twisted into cutting their wages, while thousands more employees were simply cut loose. In 2004, sighs W. Douglas Parker, chairman and CEO of America West Airlines (AWA ), "we got a cold glass of water thrown in our faces." As 2005 progresses, though, all the pain that airline workers and shareholders have endured may start to pay off. Granted, the airline industry is poised to lose money for the fifth straight year. ATA Airlines Inc. already has auctioned a good chunk of itself to Southwest Airlines Co., and US Airways Group Inc. is warning it may have to sell off its assets, too. And every old-line carrier is pressing workers for more givebacks with the threat of more layoffs. Yet if labor surrenders, giving back more pay and giving up pensions, many of the major airlines could restructure themselves into the black in 2006.

One good sign: Travel is finally perking up. Corporate America has told its road warriors to get back in the skies and drum up business. Leisure travel is on the upswing, too. After two down years, traffic at Walt Disney Co.'s resorts rose in 2004 and analysts are boosting their 2005 outlook. Coming off a strong 2004, Hilton Hotels Corp. says higher occupancy and room rates could swell its revenues per room by 7% in 2005, raising earnings 25%. Cendant Corp., which owns Days Inn and Ramada hotels, as well as car-rental outfits Avis and Budget, also expects gains. All told, hotel rates will increase 7.5% and car-rental rates will rise 5% this year as demand approaches 2000's peak, predicts the National Business Travel Assn.


So why aren't airlines profiting yet? Record-high oil prices deserve much of the blame. With the exception of labor, fuel is typically an airline's biggest expense, and fuel costs jumped 40% in 2004, to $15.5 billion, says analyst Jamie N. Baker of J.P. Morgan Chase & Co. There's little chance that oil prices will fall significantly in the new year, according to Robert N. Ashcroft of UBS Securities.

Overcapacity is the industry's other bane. Airlines expanded capacity by 6% or more in 2004 as low-cost operators fought with entrenched majors for market share. And overall capacity should rise again in 2005, by as much as 4.5% -- even more if money-losing discount carriers ATA and Independence Air Inc. disappear, as Ashcroft expects. True, traffic is also climbing, but not enough to give airlines leverage. The likely result is rock-bottom fare wars as carriers struggle to fill all those added seats.

Airline executives face some tough decisions. In addition to locking in cheaper fuel by hedging, each of the major airlines is trying to crunch costs further by reducing wages or headcounts. Northwest, which won a 15% pay cut from its pilots in November, or $265 million a year, now wants $685 million in annual savings from everyone else. Delta aims to eliminate up to 7,000 jobs this year and is pulling out of its Dallas-Fort Worth hub, eliminating 233 flights. United says it will drop 12% of its domestic schedule in 2005.

Painful as they are, the cuts should give old-line carriers a fighting chance in the long run. All the same, barring a plunge in oil prices, 2005 will be another trying year for this long-troubled industry.

By Michael Arndt in Chicago

    Before it's here, it's on the Bloomberg Terminal.