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Airline turbulence

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The domestic airline industry is in desperate need of some wind beneath its wings. Despite a strengthening economic environment and a surge in passenger demand in 2004—an 11% increase over 2003—the industry has been suffering to the point where Delta initiated a price war late last year, which was reciprocated by the other domestic carriers (New York City to Fort Lauderdale for $65!).

As illustrated in the chart below, provided by Roger King, airlines analyst at independent research provider CreditSights, the domestic airlines have been unable to do that singular thing that makes investors so happy: to make money in their core activity. The chart shows the available set per mile (ASM) margin for domestic airlines, which measures passenger revenues minus operating costs.

“For a lot of reasons these airlines can’t make money hauling passengers,” says King. “Almost every cost is overhead. And since the variable costs are miniscule it has become a commodity business, so you end up with price wars. Even now that demand is strong, there are price wars.”

Only one of the five airlines that aren’t currently operating out of bankruptcy posted a fourth-quarter profit: Southwest Airlines. Delta Air Lines reported a fourth-quarter loss of $2.2 billion which pushed its 2004 losses up to $5.2 billion—the worst loss in the industry’s history. Continental reported a $206 million fourth-quarter loss versus a $47 million profit from a year ago, while American Airlines reported a $387 million loss for the quarter.

Indeed, the airlines’ performance in the secondary market is indicative of the problems beleaguering the sector. Delta Air Lines 8.30% issue due 2029 was recently trading at 39.75 points, according to MarketAxess, down from 51 points in the beginning of the year. But things will probably get worse for some of these carriers before they start to get better.

“Bonds on some of these airlines will go to zero and the survivors will go up,” says King. “US Air is in the biggest trouble, along with Delta and United. If those three go down, that’s 40% of capacity. You’ll get a lot more volume per overhead, and the economics start to look better.”

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