The airline industry is getting ready to report first-quarter profits and there is a feeling of anxious anticipation. First-quarter results for 2006 were the best in recent years and there is a feeling that the trend will continue into 2007 (notwithstanding the number of companies in bankruptcy)—thereby confirming a turnaround in fundamentals—or at least as good as one can get in the airline industry.

CONTINENTAL and SOUTHWEST — Post Profits, But Not Until the Numbers Were Tortured to Confess

Continental’s bid for Delta bears witness to a general feeling of confidence, particularly after correctly anticipating fuel trends and adopting appropriate fuel-hedging strategies. Revenue growth seems to have benefited from inhibited capacity growth (fewer airlines, for starters, and a limited availability of newer aircraft), stronger air-fares, growing passenger confidence and volume. Southwest Airlines and Continental Airlines posted net profits for the first-quarter this year—setting a positive tone going into 2007, which might extend to some other carriers. Southwest’s net income rose to $93 million, 12 cents a share, from $61 million, or 7 cents, in the year-earlier period—that’s the good news. Operating profit, however, fell approximately 14% to $84 million from $98 million due to a 12% increase in fuel costs. Continental’s net income totaled $22 million, or 21 cents a share—including a $7 million contribution from the sale of its investment in ExpressJet Holdings—thereby reversing a loss of $66 million, or 76 cents, in the year-earlier period.

AMR, JetBlue Airways, US Airways Group, America West, Delta Air Lines and Northwest Airlines ... Well, Let’s Say, They’re Still Standing

Expectations for the balance of the industry; specifically, AMR, JetBlue Airways, US Airways Group, America West, Delta Air Lines and Northwest Airlines are not as optimistic. Weather-related flight disruptions, cancellations, rising fuels cots, and customer cries for vastly improved service, have lead each to prepare the market for a noticeable impact on net income—that’s the good news. The industry was plagued with serious weather-related disruptions in operations and it appeared as though customer revolt, notably the “Airline Bill of Rights” advanced by JetBlue, and the possibility that Congress would enact restrictive legislation, did not bode well for the sector. Fortunately, Congress was preoccupied with “other” pressing matters, as airlines did not make the hit-list (fortunately).

Evidence of the improvement is found in our weekly risk premium indicator rising to 8.04% (April 13, 2007) versus 8.63% in January 2007. Although it seems futile to discuss P/E multiples and risk premiums in this sector, the slightest gains in RORs for airlines are not to be minimized—Southwest and Continental were responsible for the improvement while the regionals and legacies remained unchanged.

The bottom line for AMR and JetBlue is likely to evidence the weather-related operating difficulties, flight cancellations and intense customer dissatisfaction—which was atypical of the JetBlue customer, with evidence of any lasting detriment to its customer-oriented reputation to be gauged in future quarters. Moreover, JetBlue’s successful fuel-hedging strategy has enabled it to prosper, without coming at the expense of customer approval. The combination, however, of a blemish first-quarter and the need to capture the fuel cycle just right, pose a great challenge. The US Airways merger with America West is likely to take its toll on first-quarter results and the company anticipates to be nominally in the black for 1Q.

Finally, it is almost ironic to discuss Delta’s and NorthWestern’s first-quarter result since both are still in bankruptcy. And while each is expected to emerge from Chapter 11 shortly, the significant post-bankruptcy losses cannot be recurring if investors are to feel confident that these companies have exited as healthy, viable entities—which is the bankruptcy court mandate. Both Delta and Northwest need to build investor confidence in the remaining quarters before a “rebound” can be declared.

Airline woes are not limited to U.S. carries, the Italian government has been actively seeking to unload its responsibilities to Alitala for the past year—after giving the company a major capital infusion nearly two years ago.

Can Airlines Every Be Profitable? Yes, with a little help from Congress & FASB
This is one Industry Washington Can Make A Meaningful Contribution to Fix

The chronic problems in the airline industry may at some point require Federal intervention. The public is already uneasy about air travel (despite the passenger miles posted), due to terrorist activities and concerns over financial short-cuts. A return to full regulation is clearly unrealistic but with the SEC expanding its influence on the Financial Accounting Standards Board, some modifications to Accounting Standards, with Congressional approval, could go a long way toward building investor and consumer confidence in the sector—thereby conveying a vibrancy not seen since the advent of deregulation. Little more than determination is required for Congress and the FASB to restore a much stronger semblance of financial integrity to the sector—one which might even serve as model for other countries to follow.