Even a Profitable Airline Industry Can Cause Turbulence for Investors

Despite an earlier forecast for a loss, the world's airlines now expect a $2.5 billion profit in 2010, the industry's first full-year profit since 2007. Investors, however, should follow the lead of the International Air Transport Association (IATA) and take the forecast with a grain of salt.

Giovanni Bisignani, IATA's director general and CEO, struck a cautionary note about the industry's new-found prosperity at the group's 66th Annual General Meeting in Berlin on Monday. He pointed out that Asia-Pacific carriers will have $2.2 billion in profit, North American carriers will earn $1.9 billion, Latin American airlines will return $900 million, and Middle Eastern and African carriers will each deliver profits of $100 million. However, not surprisingly, airlines in Europe are struggling because of the region's weak economy and will post a $2.8 billion loss. Revenue is expected to be $545 billion this year, up 13% from $483 billion in 2009, when carriers lost about $10 billion.

A "Modest" Celebration

"It is a reason to celebrate," Bisignani says in remarks posted on IATA's website. "But with a margin of 0.5%, it will be a modest party. And we face real downside risks."

Indeed, Wall Street seems to have shrugged off the report. Investors have gotten burned a number of times over the last few decades and many of the same problems that have plagued the industry in the past still remain.

For instance, carriers may be tempted to add additional capacity to keep up with rising demand. This year, 1,340 aircraft are expected to be delivered, with only 500 of them for replacement. Over-capacity has been a long-standing problem in the industry. Airlines remain as eager as ever to reduce costs as reflected in this year's announced merger between United Airlines parent UAL (UAUA) and Continental Airlines (CAL), which would create the world's largest airline.

From 2000 to 2009, the industry reported cumulative losses of $47 billion, so labor costs remain a concern. That, of course, can't be sustained in this highly unionized industry, according to the IATA. "Pilots and crew must come down to earth and strikes at this time are short-sighted nonsense," Bisignani says. "Labor needs to stop picketing and cooperate." Neither the Airline Pilots Association nor the Association of Flight Attendants-CWA could be immediately reached for comment.

Rising Oil Prices Would Directly Impact Profits

Oil prices remain the industry's Achilles' heal. As Reuters recently pointed out, American Airlines parent AMR (AMR) paid $211 million more on jet fuel in the first quarter than a year earlier and AirTran Holdings (AAI) said that a further rise in prices would cut directly into profits. Crude now trades for about $70 per barrel on the New York Mercantile Exchange. Goldman Sachs Group, though, expects it to hit $85 to $95 this year and possibly $100 by 2014. Some analysts, however, argue that prices will stay depressed because of the implosion of the economy in Europe. But that view may be in the minority.

"Prices for near-term futures options contracts suggest that the market attaches significant likelihood to the movement of prices over a wide range within a relatively short period," according to the U.S. Department of Energy's Energy Information Administration. Such volatility puts an even bigger question mark over airline profitability.