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U.S. Airlines Profits Lower in 2011

Zacks Equity Research

The U.S. airline industry earned a profit of $390 million in 2011, which is lower than $2 billion projected by the International Air Transport Association (:IATA). The 2011 profit also plunged 86% from $2.7 billion earned in 2010. The industry has been struggling with either mounting costs, fuel in particular, or economic uncertainties. The trend, it appears, will continue this year.

Fuel price volatility is the major threat to the airline industry and represents about 35% of total expenses, up from 30% in 2010. North American airlines yielded 0.3% of the net margin, down from 2.2% in 2011. Revenue climbed 12.6% year over year with total expenses rising 15.5% primarily due to a 36.1% rise in fuel costs.

Airlines are also losing money due to poor customer service, which is considered as a key growth metric. Customer service metrics are based on a number of operational measures such as baggage handling, on-time arrivals, long and excessive delays, bumping of passengers, flight cancellations and complaints filed with the Department of Transportation (:DOT).

U.S. airlines have outperformed in 2011 in three major metrics – baggage handling, on-time arrivals and bumping of passengers – relative to other regional air carriers. Additionally, customer complaints have dropped to 1.18 per 100,000 passengers from 1.20 in 2010.

2011 marked the second consecutive year of airlines making the profit after incurring cumulative losses of more than $50 billion during the past 10 years. The carriers are taking several steps to regain their lost profitability. Fare hikes and fuel hedging are the most effective tools to abate the negative impact from fuel prices.

The companies’ ability to pass along the increased costs of fuel to their customers is limited by the competitive nature of the airline industry. However, the carriers have been successful till now in passing along the higher prices to customers in the form of fare hikes. Hedging strategies provide a cushion to the rising fuel prices and is being used extensively by most of the air carriers.

Moreover, the carriers are cutting capacities and adding new features to their services as well as introducing new products, which are enhancing their value and profitability. These measures will fuel revenue growth and reduce non-fuel costs.

Air carriers are further focusing on fleet rightsizing. Though initially expensive, this seems the correct strategy to lower non-fuel costs. Air carriers are replacing their older fleet, which are no longer feasible in a fuel-expensive environment, with a new fuel-efficient aircraft.

Going forward, we will be carefully watching whether the cost-cutting measures and several initiatives help airlines to overcome the rising fuel prices. Additionally, we believe North American airlines like United Continental Holdings Inc. (UAL), Delta Air Lines (DAL), Southwest Airlines Co. (LUV), JetBlue Airways Corporation (JBLU) and US Airways Group Inc. (LCC) that were untouched by the ongoing Euro-crisis will benefit the most in 2012.

Thus, we are maintaining our long-term Neutral recommendation on Delta, United Continental, Southwest and JetBlue. For the short term (1–3 months), JetBlue retains the Zacks # 2 (Buy) Rank while the rest hold the Zacks # 3 (Hold) Rank.

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