Barclays optimistic for airlines in 2011


Despite tougher comparables, Barclays Capital expects underlying airline industry trends to remain positive, according to its research note issued last week. The company expects revenue per available seat mile (RASM) to rise in the high, single digits in January and March and double digits in February, possibly because of the snowstorms that hit the industry last February.

Revenue acceleration during 2010 sets up strong comps in 2011,
especially in the first half

Expect high single to low double-digit monthly RASM growth in 1Q

Harsh snowstorms in December are expected to blunt fourth quarter US airline results with a similar impact of the “snow bomb” in the second week of January. United Continental Holdings reported the December storms cost it USD10 million in profits and USD25 million from lost passenger revenue. Pointing to the Christmas storms in the US and Europe, Delta said its profits have been reduced by USD45 million. That is on top of the USD150 million lost by US airlines in last winter’s storms. 

Offsetting the storm damage was the third successful fare hike in the past few weeks. FareCompare.com reports that domestic airfares have increase between USD4-10/round-trip based on distance, the first such hike this year. The last time fares increased at this pace was when oil was rising dangerously in 2007/08.

“While fuel prices have been hovering near recent highs, it appears these hikes are more likely related to continued domestic capacity discipline along with strengthening demand,” said FareCompare co-founder Rick Seaney.

Barclays said the storm damage doesn’t affect its enthusiasm for airline shares and pointed to the fare activity as working to offset rising fuel burdens.

Fuel concerns

While share activity suggests the Street's worries over rising fuel prices, Barclays is not that worried.

“Fortunately, the industry is far better at adapting to higher fuel than recent share price action would suggest,” said the company. “We wrote the industry’s obituary at fuel prices far lower than these a few times before we learned that lesson for ourselves. During the last week of the year ... the industry continued to work at finding a pricing solution to rising fuel levels. In our view this fare hike attempt is still playing out with legacy carriers having matched large portions of the increase and more limited matching from low-cost carriers. The industry is obviously acknowledging the need for elevated fares, which is an important first step. Based on that experience, we expect a capacity response to fuel if higher published fares do not produce higher realised fares.”

Despite concerns, Stifel Nicolaus analyst Hunter Keay went so far as to predict higher oil prices will be good for airlines as management continues to heed the lessons of the 2008 oil spike.

"We believe the financial success of airlines in 2010 largely traces back to fear,” he said in his industry report. “That is, airline management teams fearing an uncertain economic recovery, fearing another liquidity crisis from an exogenous shock (eg terrorism), and fearing a sharp escalation in oil prices vis-à-vis 2008. This fear has resulted in a comprehensive restructuring of the industry, driven by ubiquitous capacity cuts, that should contribute to accelerating earnings growth into next year, even with expensive jet fuel.”

Raymond James analyst Duane Pfennigwerth expressed concerns to the Wall Street Journal for 2011, indicated that airlines must raise revenue above Wall Street forecasts if they are to meeting their 2011 profit goals.

Short term it will likely hurt the industry, Mr Keay said, but in the long term management actions will result in more capacity discipline, addition ancillary revenue – introduction of a USD25 fee on the first bag on international routes – reduced bargaining power for labour and changing fuel hedge strategies. He also expects consolidation to be matched by a continuing unavailability of credit for new entrants.

US Airways President Scott Kirby seemed to confirm Mr Keay’s assessment on hedging when he told the Wall Street Journal the company stopped hedging in 2009 and since then has saved USD126 million in the first three quarters of 2010. He described hedging as “a large wealth transfer from industrial companies to Wall Street trading desks. It's an incredibly expensive insurance policy." However, he said the rising cost of fuel will mean US Airways will have one of the highest fuel costs in the industry.

"Assuming airlines introduce a USD25 fee for first checked bag on international long-haul flights,” Mr Keay wrote, “we believe the industry could add USD2.7 billion in earnings in 2011, which would equate to ~150bp of incremental operating margin."

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