Turbulence Ahead for Airlines?
If you're betting on airline companies, you could be in store for a rough few months. Low-cost carrier Southwest Airlines (NYS: LUV) recently announced that it may not post a profit in the first quarter. And this dismal scenario is not just limited to low-cost airlines that function on thin margins. Other carriers such as Delta Air Lines (NYS: DAL) are also cutting their profitability forecast for the near future.
Although the first quarter is traditionally one of the weakest performing periods during the year for the airline industry, it is important to find out whether these companies' expectation of low profitability has more to it than just seasonality. Burgeoning oil prices seem to be the main culprit.
The costly liquid
Oil prices are continuously spiking up, denting the delicate economic recovery that, in turn, determines the fortunes of the airline industry. What does not help either is the fact that jet fuel prices are the biggest part of airline operating expenses. From January 2011 to January 2012, the price of jet fuel increased by as much as 18%, leaving airline companies with few options.
Airlines are estimated to consume 48 million gallons of fuel per day, and rising prices are only adding to the burden. Southwest Airlines now expects its forthcoming net income to be in the red. The company had estimated its increase in fuel costs to the tune of $3.35 per gallon, lower than the actual increase of $3.50 per gallon.
And it's not that the company did not make an effort to cover its rising costs. In the past year, Southwest has increased its fares as many as 10 times to improve revenue and counter costs. Other airlines have also increased prices. However, fare hikes always come with a downside -- the prospect of losing customers
To add to their woes, most airlines are witnessing lower capacity utilization. Southwest complained of relatively low passenger traffic in February. This reflected in its passenger revenue per available seat mile (a significant metric), which grew by a disappointing 4% as compared to 7% in January. This was also the case with US Airways (NYS: LCC) , which experienced low bookings during the beginning of February.
While Southwest offered recurrent fare sales in a bid to attract more customers and push up revenue, the recent round of fare hikes doesn't seem to be working well to boost revenue.
Each airline company seems to have its own approach to the fuel problem. For instance, United Continental Holdings (NYS: UAL) , one of the largest carriers, is offsetting pricing pressure by cutting capacity. The company may cut down on its seating capacity by as much as 1.5% to trim costs and position itself to raise fares.
Delta expects a $250 million increase in fuel costs, which is likely to hurt its projected operating margin, cutting it down to as low as 1% to 3% compared to 4% forecasted before. The airline says it is remodeling its strategy accordingly, including employee severance arrangements in its attempts to stay afloat.
Rising oil prices are a serious concern for all airline companies, which has led many of them to switch to more fuel-efficient aircraft. Southwest is leading the initiative and has placed an order for 150 fuel-efficient 737 MAX planes from Boeing. Other companies are likely to follow suit.
What happens next?
While a lot depends on fuel prices and the companies' ability to curb costs and operate efficiently, the slowly improving economic environment could start helping the airlines. For me, I am keeping a watch for the right opportunity to enter the industry.
What do you think? Post your comments below.
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At the time this article was published Navjot Kaur does not own shares of any of the companies mentioned in this article.Motley Fool newsletter serviceshave recommended buying shares of Southwest Airlines. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.
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