Research Roundup: US Airline Industry
News that American Airlines (NYSE: AMR) had to cancel 300 flights to inspect its fleet of 300 aging McDonnell Douglas MD-80s is just the latest straw breaking the back of the airlines.
American’s action comes on the heels of Southwest’s (NYSE: LUV) grounding of 43 of its older Boeing 737s for inspection. American was followed by Delta (NYSE: DAL), which began canceling flights to inspect 133 planes. While some argued that this was the airline inspection system working as it should, it’s hard to see it as positive news for the struggling industry. Recognizing the problem, a senior FAA official has called for changes in inspection mechanisms.
The pilot’s blocking of the proposed merger of Delta and Northwest (NYSE: NWA) effectively has put the brakes on another round of airline consolidation, while persistent $100-a-barrel-plus oil prices continue to put the squeeze on operating margins. The Wall Street Journal this week reported US Airways (NYSE: LCC) said fuel costs are forcing it to cut many of its midnight flights through its Las Vegas hub, a potential blow also to the ailing gaming industry. And Delta has announced plans to shed 2,000 jobs and close to 50 planes.
Following up its negative outlook for the industry, CreditSights estimates that several major airlines will need to increase passenger revenue per available seat mile (PRASM) by 7-11% to avoid breaking debt covenants, which it thinks unlikely. However, since these same airlines are overcollateralized and awash in cash they should be able to meet debt-holders demands to extract value from the issuers, CreditSights says in Airline Term Debt - Overcollateralized and Undercovered.
Loan holders are in a position to demand paydowns, and the airlines have cash to “burn.”
Standard & Poor’s on March 24 lowered its outlook on American to Negative from Positive and for US Airways to Stable from Positive.
Longer term, the maintenance and energy trends could help plane manufacturers such as Boeing (NYSE: BA) and Airbus, (Euronext Paris: EAD) if airlines speed up swapping out older planes for newer more fuel-efficient models. But that’s if and when the airlines can afford it. The main beneficiaries could be makers of smaller “regional jets,” such as Bombardier (Toronto, BBD.A) and Embraer (NYSE: ERJ) if the airlines continue the trend of “downscaling” their fleets.
Noting that fuel prices continue to outrun revenues, Credit Suisse on March 19 said “based on the capacity cuts we’re seeing & anticipating (& the pricing power that implies), believe the industry evolves to be profitable with crude at $105, though not profitable enough given the need for the airlines to reinvest in the business.”
The firm put the odds of a Delta-Northwest merger at 75% by the winter, and said failure to reach a deal would be bad news for Delta, especially in the event of a merger of Southwest and AirTran (NYSE: AAI) “a scenario we view as more likely than not at some point.”
Anticipating “a modest revenue reversal of 6-7%, beginning in Q2″ JP Morgan on March 12 broadly lowered its estimates and ratings for airlines, cutting Delta and Continental from Overweight to Neutral and most others to Underweight.
In a March 10 Primer on Airline Antitrust, Morgan Stanley said the economic case for consolidation remains strong.
In short, we see the rapid proliferation of low-cost carriers and their proven ability to successfully enter hubs as well as the continued liberalization of the international air transport system as structural trends that, on the margin, increase the probability of any merger between two airlines being approved today as compared to 2001.
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