Fares and fees add up to strong 3Q for airlines

AP News
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Posted: Oct 18, 2010 4:12 PM
Fares and fees add up to strong 3Q for airlines

Fewer seats, higher fares and more money from fees may just add up to the highest quarterly profit in three years for the nation's long-suffering airlines.

When they report third-quarter earnings this week, each of the nine largest U.S. airlines is expected to post a profit, something that hasn't happened since 2007. Wall Street estimates their combined profit at about $2.4 billion for the quarter. The best third quarter on record for the U.S. airline industry was $3.5 billion in 2007, according to government figures.

Demand for corporate and leisure travel has picked up, but airlines have been disciplined about limiting the number of planes they fly. That way, they can raise fares and waste fewer empty seats. Carriers have also boosted revenue by charging fees on everything from baggage to unaccompanied children.

Those conditions are favoring the so-called legacy airlines whose roots go back decades _ carriers such as Delta, United and American. The biggest airlines accounted for the bulk of the $23 billion in losses the industry suffered in 2008 and 2009, when first higher fuel prices and then a recession hit the airline industry hard. Now, American Airlines parent AMR Corp. should see its first profit in two years. Delta Air Lines Inc. is expected to rebound to a profit of $730 million after losing $161 million in the year-ago quarter.

Airlines have increased their revenue per mile flown _ a key industry metric _ and bookings for future trips are looking strong, said Helane Becker, an airline analyst for Dahlman Rose & Co. She believes most airlines will set or approach records for third-quarter earnings.

In the past, at the first sign of good times, the airlines would be their own worst enemy by rapidly adding flights. That led to a surplus of available seats, or excess capacity. Subsequent fare wars would lower prices and produce more losses.

This time, however, after cutting capacity during the recession, airlines have held it in check. After a 7 percent cut in capacity last year, airlines have added back less than 2 percent this year.

If the airlines can avoid expanding too rapidly, "2010 will prove to be a turning point in industry profitability," Becker says.

Over the last several years, discount airlines such as Southwest, JetBlue and AirTran have often outperformed their older counterparts as they managed costs more effectively and passengers embraced low fares. Now the legacy carriers appear to have the upper hand because they benefit most from the recent increase in business and international travel, says Kevin Crissey, an airline analyst for UBS.

And then there are the fees on checked baggage and other services. They're still a small part of overall revenue, but along with higher fares, they have helped airlines record the highest operating profit margins since the government started keeping track in 2002.

Delta leads the pack when it comes to fees _ $681.6 million in the second quarter, up two-thirds in just a year. In total, the airlines took in $2.1 billion of fees from April through June, a figure likely to have increased in the third quarter.

Some fees can be hard to spot when travelers book tickets online. A group of corporate travel executives are lobbying the government to force airlines to fully disclose fees. The group also wants fees refunded when bags are lost or delayed.

Even if travelers aren't happy, Wall Street is smiling. The Arca index of airline stocks is up more than 25 percent since the start of the third quarter on July 1.

Delta and AMR lead off the earnings season on Wednesday. Delta is expected to earn an adjusted profit of 93 cents per share, compared with an adjusted profit of 6 cents per share last year.

AMR is expected to report earnings of 33 cents per share, or about $110 million. That's noteworthy because American was the only major U.S. carrier to lose money in the second quarter.

On Thursday, United and Continental _ now part of a new company called United Continental Holdings Inc. _ are expected to report combined earnings of about $1 billion.

The third quarter runs from July 1 through Sept. 30 and includes much of the peak summer vacation season. Planes were often full, and average fares ran about one-fifth higher than last year.

Analysts will be watching closely to see if the airlines' discipline on capacity holds or breaks down.

Recently airlines have added more flights. United, American and Southwest increased capacity last month by more than 4 percent, and Delta boosted it 6.6 percent, compared with September 2009. However, that's coming off very low levels from the recession. Other than Southwest, which doesn't fly overseas, much of the increase was on international routes where demand has been strongest.

AMR President Thomas Horton doesn't see the increases as a sign of trouble for the airlines.

"No, I think we're in for a period of relatively restrained capacity as compared to prior financial recoveries," he said in an interview.

If that happens, 2011 could be another strong year for airline profits.

J.P. Morgan analyst Jamie Baker says indicators point to record industry profits next year. He predicts airline revenue will grow at double the rate of the economy. If that sounds implausible, he notes that airline revenue rose 6.5 percent in 2008, even as the country was sliding into a recession.