In early July, U.S. airline stocks were so battered you could buy one share each of five big airlines for less than the cost of checking a single bag.
With oil prices then approaching $150 a barrel and air travel demand sinking, Wall Street's view was that most of the USA's airlines were destined for bankruptcy reorganization — some for liquidation — when their cash ran out within 18 months. One or two, the thinking went, would be toast by spring.
Now the summer season's end is approaching with an eight-day Labor Day travel period for which the airlines' trade association forecasts a sobering 6% drop in demand from a year ago. Yet conventional wisdom about airlines' survivability is changing rapidly, thanks in large measure to a $30-plus drop in the price of a barrel of oil.
Don't get too excited yet — airlines' financial health is notoriously volatile. But a combination of factors could help most, maybe even all, of the USA's big airlines dodge the bankruptcy filings and liquidations so widely predicted only a few weeks ago.
Over the last five months airlines have laid in deep capacity cuts, boosted fare prices by unprecedented amounts, and begun generating lots of new revenue by charging fees for services that used to be included with the ticket price. They've also refinanced debt, sold assets, and issued new stock to build up extra cash in hopes of surviving long enough for one or more of their competitors to fail — an event that presumably would greatly improve the surviving carriers' health overnight. Airlines, however, may not have to wait for one of their number to fail in order to get healthy financially.
Oil prices, which triggered the crisis in the first place, have fallen even faster over the last five weeks than they rose during the first half of this year. Since peaking above $147 a barrel on July 11, oil has fallen to $115. That's the fastest, most dramatic decline in history.
And though most carriers still can't turn a profit at existing jet fuel prices, they're getting close to the break-even point.
Another $10 to $15 drop in the price per barrel, which some oil experts now say is possible, will have most of them back in the black. Analysts at both Morgan Stanley and JPMorgan Chase even are suggesting that the haggard industry could be profitable in 2009.
As a result, investors are jumping back into airline stocks. The AMEX Airline index has almost doubled, to 23.67, after bottoming out at 12.66 on July 15. Shares of UAL uaua, United's parent, have risen nearly 350% in five weeks, while shares of Continental cal and AMR amr, American's parent, have gone up about 150%.
Morgan Stanley's William Greene calls the drop in oil prices a "game-changing event" and says investors now are beginning to focus on airlines' improved liquidity and their surprising access to the capital markets.
Oil price retreat is a relief
JPMorgan analysts Jamie Baker and Mark Streeter told investors in an Aug. 12 report that the "industry today is a significantly different one than that which gave us pause last March."
It's not just because jet fuel prices have fallen by more than $1 a gallon from their early summer peak, though that change by itself will save the industry more than $13 billion annually. The carriers' recent capacity cuts, decisions to ground old, fuel-inefficient planes and to boost revenue via higher fares, and the imposition of new and larger fees are likely to be long-lasting changes, Baker and Streeter wrote.
That means that instead of focusing on "the potential magnitude of the fuel-induced cash burn, capital and liquidity options, and who might disappear, and when," as Baker and Streeter did during the first half of this year, they now are "assessing who might first return to annual profitability, and when."
The JPMorgan duo now project that the USA's seven so-called legacy carriers — conventional network carriers whose histories extend decades back into the era when airlines were deregulated in 1978 — will end 2009 with about $20.3 billion in liquidity. Previously they had expected American, United, Delta dal, Continental, Northwest nwa, US Airways lcc and Alaska alk to end 2009 with a total of just $12.4 billion in cash and short-term investments.
Worries about Frontier
Still on the critical list: Denver-based Frontier, the USA's 11th-largest airline.
That struggling low-cost carrier entered Chapter 11 bankruptcy in April to avoid having the credit card processing company that handles its credit transactions soak up the majority of its dwindling cash pile as protection against the carrier's possible collapse.
To stay aloft, Frontier this month received the first $30 million of what could become a $75 million loan from several of its largest shareholders. It will get that extra $45 million only if management can win contract concessions from workers who already are at or near the bottom in industry pay. Further complicating the survival picture, Frontier is caught in a squeeze at its home base. Denver is both a United hub and a major growth market for mighty Southwest luv, the juggernaut discounter that hasn't reported a quarterly loss since 1991.
Still, with the exception of Frontier and perhaps one or two other very small or undercapitalized carriers, the talk of airline liquidations in the near future was "overblown" even before oil prices pitched downward last month, says Roger King, a veteran airline debt analyst at CreditSights. Yes, he says, airlines face some monumental financial issues, including oil prices that remain higher than they ever were before this year.
"But people need to realize that these big airlines have big resources," King says. "They have horrible income statements and balance sheets. But they have what I call inertia."
Mining rich revenue streams
Millions of travelers remain steadfastly loyal to their airlines, King says, don't seem to be fazed much by rapidly rising fares, and will continue flying almost no matter what. That means airlines will continue to have large, predictable streams of revenue that will be highly valued by lenders and creditors, even when revenue doesn't cover operating costs. Those lenders and creditors would rather keep airlines flying and generating cash than repossess collateralized assets such as airplanes that would be idled for months, or even permanently, by a repossession.
"Airlines also can pull all these hidden assets out of every little nook and cranny and sell them to keep going," King says.
He points to the experience of Pan American World Airways, which lost money for more than 20 years before finally shutting down in 1991. Pan Am managed to stay in business all those years by slowly selling or refinancing all sorts of assets and subsidiaries, including its aircraft, many of its international routes, its landmark headquarters building in Manhattan, its inventory of spare parts, and even a subsidiary that did the turnaround processing on the Space Shuttle under contract to NASA.
"Small carriers may not be able to do that, but these really big airlines have tremendous underestimated staying ability," King says. "People talk about bankruptcy and liquidation, but they don't understand how deep these big airlines' resources really are."
That's not to say that U.S. airlines suddenly have become pictures of financial health. They have not.
The highest-scoring U.S. carrier among 32 conventional network airlines from around the globe recently ranked by Aviation Week & Space Technology magazine in regards to its financial health was, somewhat surprisingly, Alaska Airlines. Aviation Week's team of aviation financial consultants and analysts considered carriers' liquidity, fuel costs, earnings performance, asset utilization, operating profile and overall financial health. The latter included debt-to-equity ratios, cash balances, access to capital, operating margins and cash flow. Alaska's score was 56. Top-rated Singapore Airlines scored 93.
Southwest, the only U.S. carrier with an "A" credit rating, ranked fifth among 28 discount carriers from around the world, and second among all U.S. carriers, behind Alaska. But as highly regarded as Southwest is in the USA for its consistent profits, its score of 54 was only a little better than average and good enough only for the 20thposition among the total of 60 carriers ranked by Aviation Week.
"The health of the industry remains in question," says Calyon airline analyst Ray Neidl, a member of Aviation Week's team of advisers.
Lower cash reserves
Lower fuel prices and the carriers' recent dramatic operational and financial maneuverings have helped ease the crisis, but it has not entirely passed.
Delta and US Airways are moving close to what Neidl calls the bankruptcy/liquidation danger zone based on their cash and short-term investments at the end of June as a percentage of their revenue over the previous 12 months. The danger zone, he says, is a ratio of 10% or less. Delta's cash-to-revenue ratio on June 30 was 16.1%, while U.S. Airways' was 17.4%. Both are addressing that issue.
Balance sheets expected to improve
Delta, where operating costs and performance have improved significantly as a result of its bankruptcy reorganization, should see its ratio rise above 20% upon completion of its pending merger with Northwest, which has a cash-to-revenue ratio of 24.5%. US Airways last week issued $179 million of new shares to shore up its balance sheet.
United, though, remains the closest to Neidl's danger zone, with a 14.1% ratio of cash to revenue. That ratio will rise a few points after United picked up $600 million in cash in July by renegotiating its affinity credit card deal with Chase Bank. Neidl's also concerned that United's projected cash burn for the coming winter will be larger than at most other airlines.
Yet the outlook is not as bad as it was just over a month ago when oil was $147 a barrel and jet fuel was over $4 a gallon on the spot market.
Amazingly, after all they've been through, "airlines still have the ability to raise cash" by issuing stock, negotiating new lines of credit and selling assets, he says.
And they appear able to generate still more revenue.
"All 10 of the large, publicly traded U.S. carriers should be able to make it through this year without defaults (on their loan agreements and covenants), even in a weak economic environment with high fuel costs," he says.