Credit Suisse is reviewing its earnings estimates and ratings of airline stocks following the continued surge in crude prices. CS expects most of the industry to remain solvent. It is only downgrading US Airways for now, but more cuts are presumably coming soon. CS forsees troubled times ahead should crude remain above $125.
Contrary to stock performance, the airlines remain solvent, and we expect most will. [translation: Some will go bankrupt]
But with crude apparently on the march to a super spike [Goldman trademark term], we understand why investors have concern. That said, our contrarian view that the industry would be profitable with crude at $105 to $115 goes to a mostly consensus view that crude at $125+ is problematic for earnings – a key risk we’ve warned about, but failed to incorporate adequately into our ratings as we under-appreciated how violent crude could become in such a short span of time.
Credit Suisse stresses the need to cut costs and raise fares.The current competitive environment, however, is not conducive to the needed structural changes, and so CS sees airlines struggling in the near-term.
Double-digit CASM (cost per available seat mile) increases require double-digit RASM (revenue per available seat mile) increases, or fare increases of roughly 15%-25% depending on the airline. According to the AMEX Business Travel Monitor, [business] fares for 329 N. American city pairs are 22% to 40% lower than 2000 despite all the recent fare increases. This suggests that if the industry could claw back fares from 2000, it could offset in good part crude prices that are now 354% higher.
The pricing power needed may not seem great, but given low cost carrier hegemony, legacy carriers lack the pricing power needed in light of the current capacity backdrop. And although corporate travel and leisure demand still appear strong near-term (relative to reduced capacity), we understand that once corp travel budgets are spent this year, they’re unlikely to be replenished.
The only way to stave off further losses, CS says, is through deep capacity cuts. With lease obligations and cost structures as they are, however, the airlines will find it difficut to trim the fat:
Consequently, we believe the industry does need to cut 15-20% capacity for starters, but at this point, it’s poorly positioned to do so. Scope clause provisions, lease obligations and cost structures designed for larger, more lucrative networks all limit the industry’s ability to sufficiently cut capacity and costs. That said, we factor into our models 10% domestic capacity cuts starting in 4Q, which should be enough, when combined with a few more failures that we anticipate, to support pricing into 2009.
CS is therefore cutting its rating of US Airways (LCC) to Underperform from Outperform. Southwest (LUV), Delta/Northwest (DAL)/(NWA), JetBlue (JBLU), and AirTran (AAI) remain rated Outperform.