Airlines Earnings Expected to Take Nosedive

Despite a projected third quarter growth rate of 10% and even higher projections for the fourth quarter, year-over-year growth for airlines in 1999 is expected to be down 7%, according to data provided by First Call Corp.

The outlook for passenger airlines in the high yield market is negative by most accounts, and some analysts predict the industry will hit bottom over the next eight weeks.

While the airline industry as a whole has been plagued by difficulties and setbacks - wrecked labor relations, rising fuel costs, weather problems, and less demand for overseas travel - high yield issuers have been hit especially hard. Each of the major carriers posted losses in the third quarter and analysts expect earnings to continue to fall in the coming months.

Among the major high yield carriers, analysts predict U.S. Airways will post the biggest losses. Earnings in the third quarter are expected to fall 115%, compounded by a projected loss of another 105% in the fourth quarter. The airline is expected to end with year over year losses of 627%. (First Call estimates can reflect a decrease of more than 100% when the company is expecting a loss.)

Continental Airlines also will be posting losses this year. Third quarter earnings are expected to be down 21%, and down another 16% in the fourth quarter, ending the year down a total of 14%. Trans World Airlines and Northwest Airlines are also posting losses this year.

"Investors should not lose sight of the fact that this is a cyclical industry. As labor costs go up and non-labor costs go down, the industry's operating leverage may increase," said John Kollar, managing director at Bear Stearns.

In the last week of September, airline stocks outperformed the broader market, but ended the week down an average of 2%.

Helane Becker of Buckingham Research Group speculates airlines will top the list when investors begin looking for undervalued stocks in industries with improving fundamentals in late November or December.

According to Becker, labor accounts for 35% to 40% of a passenger airline's total operating costs, and relations between management and unionized workers are their lowest point in years, perhaps ever. In recent months, labor agreements have been rejected by U.S. Airways' Mechanics' and TWA's Mechanics' Unions.

However, Delta Airlines reached a tentative agreement with its pilots late in September that may signal a change in labor relations throughout the industry. Though Delta is not a high yield issuer, as the nation's third-largest airline in terms operating revenues, its management policies are often seen as a marker of the industry environment.

The agreement is considered favorable by Becker in two respects. First, it is the first time this year a labor agreement has been accepted without first being rejected. And, these wage rates are closer to management's initial offer than pilots' demands.

Kollar, on the other hand, does not agree that Delta's agreement is a positive sign for management.

"Theoretically, the Delta deal is the sweetest deal out there right now," he said, "My expectation would be that the resolution of the Delta contract may eventually push up pricing and further push up the pilot contract resolution cost for other airlines going forward." Higher labor costs may translate into thinner profit margins that may have to be managed by capacity decisions including fare increases and lower commission costs.

Oil prices and weather, for their part, have hampered airlines earnings as well.

Following OPEC's decision two weeks ago to maintain production limits, fuel prices have continued to rise. Jet fuel prices ended the week of Sept. 22 at $0.64 a gallon, down 2.5% from the beginning of the week, but up 39% from a year ago. However, some energy analysts expect prices to peak over the coming months, as current high levels are considered unsustainable.

Severe weather along the eastern seaboard in late August and September sliced into airlines' revenues, especially those with major hubs in the Northeast. On the Thursday that Hurricane Floyd struck the northeast, U.S. Airways canceled about 40% of its flights. Continental canceled 715 flights over a 3-day period, mostly in its Newark hub as a result of the storm. Industry-wide revenues on domestic travel are expected to be down between 7% and 8% in September.