Moody's Goes Negative on Airlines, Citing Skyrocketing Fuel and Other Costs

U.S. airlines will face an uphill battle to survive during the next 12 to 18 months in the face of rising fuel and other costs, Moody's Investors Service said in a report released last week assigning a negative outlook to the industry after three years of stability.

Cuts in airline service to smaller, regional airports may adversely impact airport revenues and bonds, said Moody's vice president and senior analyst George Godlin.

"The brief period of renewed profitability for U.S. airlines has come to an end, and large operating losses and deficit cash flows are expected for the foreseeable future," the report said.

Record fuel costs, an ailing economy and ineffective strategies by airlines to recoup their losses are among factors Moody's analysts see endangering the industry's overall credit conditions through the end of next year.

Airline profits and cash flow only began trending downward during the beginning of last year, according to the report.

Airlines were stable in the "intervening years post-9/11 before this credit crunch came in and started affecting consumer spending," Godlin said.

Moody's sees signs of trouble in the second quarter of this year as airlines add fees for checked baggage, charge for in-flight food and entertainment, and delay adding new aircraft to their fleets. However, these and other efforts, such as lowering airport costs, have failed to keep airlines' finances stable, according to the report.

A negative outlook from Moody's is "a signal to the market that the chances have increased or will increase that ... rating[s] will be downgraded," Godlin said.

Airlines are more susceptible to default when confronted with rising fuel costs, weakened liquidity, aging fleets that are less fuel-efficient and consumers who are reluctant to pay higher fares, he said.

The report said that up to 50% of the average ticket price is consumed by fuel costs, "leaving inadequate coverage of other key costs" such as debt service, overhead, labor and equipment rentals. The share of total airline spending that goes toward fuel has doubled or tripled since 2001, according to Moody's.

"Absent an ability to fully recover fuel costs in ticket prices, additional airline bankruptcies are likely and could involve larger carriers," the report said.

With fewer passengers and fewer flights expected, analysts said, smaller carriers and airports will be hit hardest.

The number of smaller carriers pursuing bankruptcy or completely stopping operations this year could grow, while it is possible that a major carrier may have to turn to liquidation, the report said. Airline mergers, however, are unlikely this year. Mergers could prove detrimental to airlines by taking attention away from successfully managing their current situation, according to Moody's.

Airline strategies to cover the climbing cost of fuel - higher fares and surcharges, less-frequent flights - are too little too late, the report warned. Fare hikes currently in effect cover just a fraction of fuel costs and capacity reductions planned by many carriers have a September start date when demand is usually on the decline anyway.

Instead of solving the crisis, the 10% to 12% planned reduction in capacity by major airlines may have a chilling effect on airport viability, Godlin said.

High-demand airports in hubs such as New York City, Chicago, Los Angeles and Atlanta should withstand the flight cuts, he said. But smaller airports in places such as Cincinnati, central Iowa or Westchester County, N.Y., may lose revenue as airlines pull flights from those less-popular destinations.

Airports with relatively fixed expenses could be stuck trying to make up lost revenue by looking to the airlines still serving those locations, Godlin said.

"The associated bonds would reflect that increased risk, especially for these secondary airports," whose bonds would carry a higher interest rate or increased bondholder returns," he said.

Commercial air service to 100 cities has been cut or is slated to be cut by year-end, according to a letter sent last month by air travel industry groups to Senate and House leaders.

The negative outlook is in contrast to a Moody's report that was released in February, which gave a stable credit outlook for airports. But that report predicted that airport credit could suffer from airline troubles.

"A prolonged recession combined with sustained increases in fuel costs could cause a spike in ticket prices or reduction in airline profits that could weaken airlines further and ultimately affect airport credit," the February report said.

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