Why U.S. Airlines Are Rebounding More Rapidly Than Europe's

U.S. Airlines Rebounding, But Europe's Carriers Are Lagging
U.S. Airlines Rebounding, But Europe's Carriers Are Lagging

British Airways (BAIRY) reported a widening loss for its most recent quarter on July 30, underlining the fact that European airlines are lagging their American cousins in returning to profitability as the world economy slowly pulls out of recession.

In the three months ending June 30, British Airways said it lost $190 million, up from the $65 million the carrier lost in the same quarter a year ago. One of the main reasons for the increased red ink was the cloud of volcanic ash that closed European airspace for a week in April following the eruption of Iceland's Eyjafjallajökull volcano.

The Geneva-based International Air Transport Association put a high price tag on the volcano's damage to the industry: nearly $1.8 billion in canceled flights and fees to move aircraft and staff out of harm's way. About 70% of those costs fell on European carriers.

Anthony Concil, spokesman for the IATA, says the group is projecting European airlines will lose $2.8 billion this year, while U.S. carriers will earn an estimated $1.9 billion in profits.

"U.S. airlines have had an enormous turnaround," Concil says. "You're seeing the economy get back to work even if you don't see the jobs being generated quite so fast. But in Europe, on top of a very slow recovery, you have currency concerns, uncertainty over the debt crisis in Greece, Spain and Portugal, and consumer confidence is being hit quite hard."

The IATA projects airlines worldwide will earn a total of $2.5 billion in profits this year, compared with $10 billion in losses in 2009.

Recovering Quickly

Most of the major U.S. airlines reported a swing back into profit this month, with the exception of American Airlines (AMR), which lost $10.7 million. Delta (DAL) earned $467 million, United (UAUA) reported $237 million in net earnings and US Airways Group (LCC) posted earnings of $265 million, with an impressive 8.8% profit margin.

Michael Linenberg, an airline industry analyst at Deutsche Bank, says the major airlines are reducing the percentage of debt on their balance sheets and expanding profit margins rather than gaining market share.

"In a cyclical recovery, major airline stocks typically outperform the market as they benefit disproportionately from an improving economy due to their significant operating leverage," Linenberg said in a note to investors. When operating leverage is high, a small increase in sales can result in a much larger increase in income.

Linenberg says the major U.S. airlines were exposed to the three areas worst hit during the global recession -- international travel, business-class travel and cargo -- and thus should well-placed to benefit from a recovery. In addition, the share of U.S. airline revenue from emerging markets is higher than ever, and growth rates in those areas are two to three times greater than in the U.S. market.

Linenberg notes that the NYSE Arca Airline Index ($XAL.X) is up nearly 20% year-to-date. By comparison, the S&P 500 stock index is down 3% in the same period.

Rising Oil Prices Put Pressure on Profits

According to the IATA, business-class travel, the most profitable part of most airlines' business, was up 10.5% in the first five months of 2010. Business travel is still weak on domestic U.S. routes, but it's growing strongly on long-haul international flights. Leisure travel, on the other hand, was up only 5.5% because consumers are still conservative in spending and are cutting back on vacation trips.

IATA's Concil says the price of oil is still having a negative impact on bottom lines. Last year, crude oil averaged $62 a barrel, while this year it's projected to cost an average of $79, a rise of 27%.

"Fuel is about 26% of costs," notes Concil, "so when you are talking about an industry with profits of just 0.05% of revenues, any shift in the price of fuel dramatically impacts the razor-thin margins that the airlines have."