Tuesday, August 5, 2008
Smart Profits Report Issue #546
by Martin Denholm, Managing Editor, Smart Profits Report If the world’s airlines were on the singles scene, looking for potential mates, many of them would be out of luck. Having dressed themselves up as best they can, slapped on their best deodorant and after-shave, you can picture them at the end of a night of unsuccessful bar-hopping, looking drunk and desperate. After all, what do they have to offer? It’s a grim business at the moment, with oil prices having pushed companies to breaking point and fuel prices now sucking up the bulk of annual expenditure. Take British Airways, for example. The company reported a 90% plunge in its first-quarter profits, as fuel costs soared by 49%. BA projects a meager 3% rise in revenues this year in what CEO Willie Walsh calls “the worst trading environment the industry has ever faced.” Speaking of BA, let’s see what’s buzzing in the skies, throwing in a little dash of recent personal experience into the mix… What’s This? A Pleasant Airline Experience… For all its British charm and tagline as “the world’s favorite airline,” BA hasn’t helped its cause this year, thanks to the PR disaster around the opening of its swanky new Terminal 5 at Heathrow Airport in London. Computers crashing. Thousands of bags lost. Hundreds of flights delayed or cancelled. The terminal resembled more of a campsite than anything else, as passengers lay around, increasingly not expecting to fly, but hoping to. I’ve flown BA many times. They’ve always done the job pretty well. But over the past few years, the company’s higher prices (relative to other airlines – and especially in terms of taxes) have put me off. Still, I chose BA for my recent trip back to Britain – and was impressed. Yes, BA ticket prices rose 7% over the past quarter, due to its fuel surcharge increase. But I nipped in ahead of the most recent hike. Besides, the height of summer means there’s little difference between airlines’ overall prices. Plus, it was a direct flight from Baltimore, with the best departure and arrival times. Not to mention… free booze! As most other airlines charge for drinks, BA has maintained its free alcohol policy on international flights. And I’m not ashamed to say that I took full advantage! There was also a plentiful and diverse selection of in-flight entertainment. And no charge for checked bags or headsets. We Brits can be a generous bunch! Consolidation Amid Chaos Its transatlantic routes like this that BA is depending on to generate a sizeable chunk of its revenue, and it seems the airline will take another stab at arranging a mega-alliance with American Airlines. With the Open Skies transatlantic agreement having increased competition, the current state of the airline industry means that more co-operation is probable. Airlines cannot afford to get into a cost-cutting war with each other at a time when profits are elusive anyway. Last week, BA detailed plans to merge with Spain’s Iberia, but its proposed alliance with AA (in conjunction with Iberia) will have to satisfy authorities that it doesn’t break antitrust laws. While not an official merger, complete with costs and bureaucracy, it allows airlines to split routes, charge the same prices, and share profits and costs. Northwest and Delta have already succeeded in this type of deal with Air France-KLM, but the BA-AA agreement might be harder to push through, as it would create a “dominant mega-power on transatlantic air routes from two of the largest EU members," according to a spokesman for Virgin Atlantic. This isn’t a new development for BA and AA. The two firms originally applied for antitrust immunity in 1997 and again in 2001, but BA refused to bow to regulators demands to give up what it thought were too many landing slots at Heathrow. But with Iberia now on board (pardon the pun), the two hope for a positive outcome. They already have strong links through the One World Alliance and Iberia’s inclusion would give BA and AA a route into the Latin American market, where neither holds a dominant position. In addition, the firms argue that recent consolidation has already strengthened the position of some of its rivals. And now that the Open Skies agreement has made Heathrow available for other airlines – rather than the previous arrangement, whereby just four transatlantic carriers could fly in there (BA, AA, United and Virgin) – the deal has a better chance of success. Relief… From Oil In addition to its transatlantic alliance efforts, BA (and indeed other airlines) is enjoying some much-needed respite from the oil market’s recent decline. With prices having slipped from $147 to around $119 in the space of just a few weeks, my colleague and commodities expert Lee Lowell said in his “Commodities Corner” column yesterday that the next support point could be $107 if the current downtrend continues. Once upon a time, that price would have caused heart attacks among airline executives, but after this year’s brutal price runup, they’d gladly take it now. Seems like a drop in oil demand from businesses and consumers alike because of the high price is finally leading to some air being let out of this blown up market. Having fallen for four straight weeks, gasoline prices are down 6% from their peak in July. And the drop is helping the airlines… Go Contrarian… It Works Take a look at this chart… 
It’s a yearly chart of the AMEX Airline Index ($XAL). Note how the drop in oil prices over the past month has led investors back towards airline stocks. Back on June 3, my colleague Marc Lichtenfeld highlighted XAL and pointed out that the industry may well be in line for a rebound if it could shrug off its two-year downtrend and form a “basing” pattern. Here’s what he said: “Keep an eye on the XAL chart. Should the index “base” (stop going down and then flatline), or even reverse the downtrend and head higher, the market is likely signaling a recovery. “I wouldn’t necessarily get into airline stocks for the long term, as I believe the business model is flawed, but an intermediate-term trade seems quite reasonable once the bleeding stops.”
In the column, Marc gave two airline stocks for potential investors to watch – Alaska Air Group (NYSE: ALK) and Southwest Airlines (NYSE: LUV). Alaska Air has edged down just 2.7%, while the ever-popular Southwest has reaped better rewards, jumping 21%. And as Marc noted from his own recent flying experiences, flights remain very full – a trend that held true on my Baltimore-London round-trip, too. The depressed dollar and lousy exchange rate certainly didn’t seem to put many folks off a jaunt to England. Not a spare seat to be had. Same story on the way back, too. Don’t get me wrong… airlines remain in trouble and a return to profitability seems a very long way off for many of them. But if oil prices continue to fall and stabilize, it can only spell good news for this most beleaguered of industries and gives it a chance to get back on its feet. Or, more appropriately, take off. Okay, that’s all I have in me today. I only got back to the US last night and have to go sleep off the remaining jetlag. Martin Denholm
Today’s Smart Profits Notes British Airways wasn’t the only airline to endure a brutal last quarter. Air France-KLM said today that net April-June profits slumped by almost 60%, compared with the same period in 2007. That was despite a 3.7% rise in passenger numbers.
The news came on the back of a report from the International Air Travel Association (IATA), who warned that the airline industry must face up to the situation getting “a lot worse” before it gets better – and backed it up with a projection for losses of $6.1bn (£3bn) this year.
Related Articles: Can You Profit From The Market’s Worst Industry? The Airline Sector: Airlines Are Headed For The Bermuda Triangle… Time To Bail Out? Investing In The Fear Effect: How To Buy Bargain Stocks When There’s Blood In The Streets
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