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Abu Dhabi, UAETuesday 11 December 2018

US airlines face more pain amid $10bn shares wipe-out

Price war that started between United Continental and heavy discounters spreads to more carriers and markets

American Airlines is one of several US carriers to be hit by a price war. Ernesto Mastrascusa / EPA
American Airlines is one of several US carriers to be hit by a price war. Ernesto Mastrascusa / EPA

UPDATE:

Delta Air Lines on Tuesday cut its forecast for passenger unit revenue, a closely watched performance metric, for the current quarter due to slower than anticipated recovery in fares for last-minute flights.

The second-biggest US airline by passenger traffic said it now expects third-quarter passenger unit revenue, which compares sales to flight capacity, to rise 2 to 3 pe rcent.

It had previously forecast an increase of 2.5 to 4.5 per cent.

Delta also cut its operating margin forecast to 16.5 to 17.5 per cent from 18 to 20 per cent for the quarter.

The company's shares were down 1.7 per cent at US$46.71 in pre-market trading.

US airline investors, already absorbing the worst monthly stock performance in a year, are bracing for more disappointment.

A Standard & Poor’s index of the five biggest US airlines plunged 7.5 per cent in August, wiping out about US$10 billion in market value. Shares fell as a price war that started between United Continental and heavy discounters spread to more carriers and markets.

Analysts see more pain ahead.

UBS Group predicts the latest skirmish will force some carriers to lower their third-quarter forecasts for revenue for each seat flown a mile, a closely watched gauge of pricing power. The trend is worrisome because the major airlines have been boasting that industry consolidation would lead to steadier profits and smoother shareholder returns - not repeated fare battles with low-cost rivals.

“We’ve taken it on the chin the last 30, 45 days, because there’s no question United started cutting fares to ward off Spirit, Frontier, whoever, and I guess it’s spread among all the airlines cutting fares,” said Gary Bradshaw, a portfolio manager at Hodges Capital Management in Dallas, which owns stakes in the major airlines. “It happened overnight almost.”

Hurricane Harvey, which shut Houston’s airports for several days last week, will be another drag on earnings because of flight cancellations and a spike in jet-fuel prices.

United and Southwest Airlines will probably have to cut their forecasts the most, said Darryl Genovesi, a UBS analyst. American Airlines and Delta Air Lines, which have been less aggressive in adding flights and seats, “may just shade to the low end of current ranges”, Mr Genovesi said.

The fare battle that started this summer between United and heavy discounters such as Spirit Airlines and Frontier Airlines has since spread to others, including American and Southwest. The S&P airlines index has dropped more than 14 per cent since June 30.

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Industry pricing declined in July from the previous month, and August “appears to have deteriorated further”, said the Cowen & Co analyst Helane Becker, citing meetings with airlines last week. While carriers expect improvement in the last three months of the year compared with this quarter, “the pricing trends are currently not favorable.”

Hurricane Harvey is only expected to exacerbate the industry’s woes. Jet-fuel prices jumped 26 per cent from Harvey’s August 25 landfall in Texas through September 1, after the shutdown of two pipelines carrying fuel and refined products from the US Gulf Coast. Jet fuel usually is the second-largest operating expense for airlines, behind employee compensation.

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Airlines “can truck in fuel, potentially look to other pipelines as a source, but that’s another headache for the industry to try to deal with”, said the Southwest chief executive Gary Kelly. While there’s no immediate danger of a shortage, Mr Kelly said last week he was “absolutely” concerned by the pipeline closures.

Some carriers are expected to use a Cowen transportation conference that starts September 6 in Boston to update outlooks for third-quarter revenue for each seat flown a mile, most likely to the low end of earlier guidance, Ms Becker said. Others may include updates on the gauge, known as unit revenue, in monthly traffic reports this week.

The current price competition probably will not lead to a long downturn for the major airlines, said the Sanford C Bernsteinanalyst David Vernon. Many of the battles are on the most competitive routes, including New York to South Florida, that already had lower fares.

Wall Street “is looking at the most competitive part of the market and using that as an analog for the entire industry”, Mr Vernon said.

The advent of discounted “basic economy” fares should allow the major airlines to compete selectively with Spirit and others without lowering fares across a wide range of routes and price categories, he said.

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Hodges is taking a bullish approach. Instead of cutting airline shares, the firm added to its position, Mr Bradshaw said. He said Delta boosted its dividend by 50 per cent earlier this year, which suggests the airline is confident it will not be dragged down by a fare war.

“They’re telling you that these earnings are going to continue to stay strong, continue to grow,” Mr Bradshaw said.

United currently expects unit revenue to be somewhere between down 1 per cent from a year earlier to up 1 per cent, while Southwest sees the measure up 1 per cent. Investors were disappointed by both forecasts, made in July, and by Southwest’s plan to grow more quickly than expected. The United president Scott Kirby declined to comment on the unit-revenue outlook last week, but confirmed the carrier would provide an update this week.

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American has said the measure will be up in a range of 0.5 per cent to 2.5 per cent from a year earlier, while Delta expects up 2.5 per cent to 4.5 per cent.

American and United will continue to match heavily discounted fares at their hub airports, executives from both carriers said. Basic economy, which allows passengers to bring only a small carry-on item, helps dull the impact because airlines limit the number made available.

“We are going to compete against anyone that chooses to compete head-to-head against us,” Mr Kirby said last week. “That’s the right strategy.”

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United’s website Thursday showed a US$50 one-way basic economy fare between Newark, New Jersey, and Fort Lauderdale, Florida, for a September 7 flight. A round-trip economy ticket on the same route was $139.50 before tax, departing September 7 and returning September 12. Southwest offered a $122.38 round-trip price, excluding taxes and fees, on the same dates and routes. Deeply discounted fares have limited availability.