In a nutshell


Dec 21, 2002
Pay attention to the labor costs being easiest to tackle!
New York Times - Four Choices for Airlines (Only One Is Probable)

Two major airlines, US Airways and United Airlines, are in bankruptcy and others may follow.
The American Stock Exchange airline index, which stood at 91.07 one year ago, is now trading at about a 67 percent discount to that level.
Sam Buttrick, an airline analyst at UBS Warburg, took time last week to talk about the industry.
Following are excerpts from the discussion.
Q. Just how bad are conditions for airlines?
A. The near-term prospects are unequivocally poor. Revenue levels remain some $20 billion below where they were in 2000, which was a historical peak. Oil prices are at multiyear highs. Labor has been understandably resistant to required changes. And recent terror alerts have further dimmed the allure of air travel across the board. It's a mess.
If nothing changes, all of the major carriers will be bankrupt within two years. But that is not the way the world works, because change is the order of the day.
Q. What might help the industry?
A. There are only four factors that are material enough to effect sufficient change in a short period of time.
First, a large chunk of capacity can be removed from the system through liquidation; second, oil prices can immediately go to $10 a barrel; third, business travel can suddenly surge; or, fourth, labor can make or be forced into major concessions.
When you consider these four possibilities, the only one that strikes us as probable is the last one. It's the only one where the math works.
We believe this year will be the year in which industry labor costs, which remain at record levels, will be rolled back.
Q. What effect have the labor concessions at US Airways had on the industry?
A. US Airways has already lowered the bar for labor. But it takes concessions at one of the larger carriers to set the tone for the rest of the industry.
The labor contracts with United Airlines will be the watershed event. What remains unclear is if subsequent packages at American Airlines and others will be negotiated inside the bankruptcy court or on the courthouse steps. Bankruptcy proceedings need to be a credible alternative to forced negotiations.
Q. What do you expect from the United negotiations, and when?
A. United has indicated that if it is unable to reach agreement by March 15, it will impose new contracts itself, under Section 1113 of the bankruptcy code.
Not all of the proposed terms of what United has asked for are in the public domain in quantified form, but we estimate the new United contracts, once fully adopted, would reduce United's labor expense by $1.5 billion to $2 billion a year, or about 20 percent to 25 percent of their current labor costs. We can't recall labor cost reductions of this magnitude.
Q. You said it will take impending bankruptcy to force labor concessions. How realistic is it that even more airlines will file for Chapter 11?
A. The possibility of serial bankruptcies is very real. But we believe massive labor concessions will occur over the next 12 to 18 months that will enable most carriers to avoid bankruptcy. But it only takes one major terrorist act in the United States to change that statement.
Q. The airline industry has been deregulated for a little over two decades now and hasn't flourished financially. Would a return to some sort of regulation help the business?
A. I don't see any calls for reregulation from any corners of influence. That being said, I don't see how the industry could do much worse than it is right now.
Q. Airline stocks have never been good long-term investments. Have they been beaten up so badly that they might be interesting, highly speculative stocks to look at?
A. History has shown us that when companies left for road kill somehow stagger back to their feet, the appreciation in the stocks is nothing short of dramatic.
Continental Airlines was left for bankrupt by the market in 1994. Over the next four years its shares rose 15-fold. The same was true for US Airways.
We expect substantial gains in the stocks of those airlines that can narrowly avert bankruptcy. But the possibility of bankruptcy is distinctly real, and no one should attempt to speculate in airline shares unless they are willing to lose the entirety of their principal. They are either triples over the next two years, or they are going to zero.
Q. So you wouldn't invest in lower-cost, profitable point-to-point airlines?
A. Southwest Airlines and JetBlue are fine companies but not necessarily cheap stocks. For exceptionally risk-tolerant investors, we believe buying a basket of financially ailing carriers potentially produces very big returns.

Other Articles

San Francisco Chronicle - United increases goal for pay cuts (2/17/2003)

New York Times - Talk of War Brings Changes in Travel Plans (2/17/2003)

Minneapolis Star Tribune - Labor cost cuts key to Northwest's survival strategy (2/17/2003)

Los Angeles Times - Airfares Climb as Fuel Cost Rockets (2/17/2003)

Pittsburgh Post-Gazette - Retirees join pilots in fight for pensions (2/14/2003)

Fort Worth Star-Telegram - Airline's unions agree to cuts (2/14/2003)

Dallas Morning News - Is Southwest's lovin' feeling gone? (2/14/2003)

Pittsburgh Post-Gazette - US Airways' pilots blast pension cuts as illegal (2/13/2003)

New York Times - United Provides Some Specifics on New Airline (2/13/2003)

Minneapolis Star Tribune - NWA sees its rivals' pay cuts as 'template' (2/13/2003)


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