Extra Bucks for Airlines -- Not for Investors

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Airlines generated revenue of about $21.5 billion last year, not from core operations, but from additional fees charged to passengers. Pretty amazing, right? The carriers have resorted to bucking up their bottom lines through extra sources of revenue in an attempt to offset the effect of rising fuel prices.

Is it a sign of good days to come for the airlines? Not really.

The extra buck
Though we know we are paying more fees while flying nowadays, a recent study revealed how much. Of course, the biggest concern plaguing airlines has been increasing fuel prices. Like their commercial banking brethren, when the airlines realized they had to come up with a way to deal with rising costs, they resorted to charging passengers more in both direct and indirect ways.

Fare hikes and extra surcharges cropped up. Most airlines resorted to a series of fare hikes. In April, US Airways (NYS: LCC) reportedly initiated the 10th domestic fare hike in 2011, as reported by FareCompare, which conducts airline research.

Now, along with higher fares, passengers are being charged with surcharges that were earlier a part of ticket prices. The result? Airline companies make extra bucks in the form of add-on revenues.

More and more airline companies are going for such money-making tactics. The number of such airlines jumped significantly in three years. Ancillary revenue was only $2.45 billion in 2007 while 47 airlines revealed a combined $21.46 billion in extra earnings in 2010. That's some pretty astonishing growth in just three years.

The leaders
Larger carriers have been generating larger ancillary revenue. The giants, Delta Air Lines (NYS: DAL) , United Continental Holdings (NYS: UAL) , and AMR's (NYS: AMR) American Airlines, have garnered the highest total ancillary revenues.

Interestingly, the first such figures released by Continental after its merger with United show a big annual gain of $5 billion. Around 14.7% of United's total revenue has come from ancillaries in 2010. Allegiant Travel (NAS: ALGT) leads the pack, with 29.2% ancillary revenue.

Delta started charging for services such as on-demand movies, Wi-Fi, and onboard meals, apart from increased baggage fee in some sectors it operates, which resulted in its ancillary revenue of $3.7 billion last year. Its SkyMiles program earned $1.5 billion for the company.

No-frills carriers were no different, with Spirit Airlines (NAS: SAVE) , which recently went public, ranking second with 22.6% ancillary revenue. The airline business model, it seems, is undergoing a silent change.

Growing trend
But why should the ancillary revenue figures be important to an investor? Well, when a significant chunk of total revenue starts coming from new strategies, it is worth taking note. Airlines are slowly venturing into a business strategy where ancillary earnings become an important part of revenue, without which the companies might not be doing as well. It clearly is an emerging trend, as the same number of airlines had reported ancillary revenue of $13.47 billion in 2009, as compared to $21.46 billion last year. JetBlue Airways (NAS: JBLU) is expecting a 20% increase in ancillaries this year, indicating a growing trend.

The road ahead
It sounds good when companies start earning more. But as investors, we are more interested in where the core business is headed, and not how the ancillary revenue grows.

Currently, the primary concern, fuel prices, is eating into airlines' profits. And there are no signs of relief. The Energy Information Administration forecasts the annual average retail gasoline prices to increase to $3.56/gallon in 2011 and taper slightly to $3.54/gallon in 2012. Furthermore, jet fuel consumption is expected to go up by 1.6% in 2012. With these forecasts, airline players will keep feeling the pressure on profits.

Fare hikes have become a norm to combat rising costs. This along with increased extra fees will be passed on to consumers. But while fares have been hiked, the carrying capacity has not shown an improvement. The U.S. airlines' load factor increased, very marginally, from 75.62% in January 2010 to 76.51% in January this year, indicating no growth.

Unless companies control costs and increase capacity and passenger numbers, among other things, revenue from extra sources will not help.

The Foolish bottom line
Recent profit forecasts for the airline industry have been slashed by The International Air Transport Association. Naturally, companies might be enjoying the extra bucks in such a situation. But for an investor, the celebrations will start only when the companies show a turnaround and generate continuous profits. Unfortunately, it might not happen so soon, giving Foolish investors a reason to maintain a cautious view on airline stocks for now.

At the time this article was published Neha Chamaria does not own shares of any of the companies mentioned. The Motley Fool owns shares of Allegiant Travel. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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