Continental Air, AMR post Q2 profit, cite impact of cost reductions but lament high fuel prices

By Paul Deckelman

New York, July 20 - Continental Airlines Inc. and its larger rival, industry leader AMR Corp., on Wednesday each reported profits for the second quarter - and both "legacy" airline companies cited the positive impact of cost-cutting moves they have made in the past year and bemoaned continually high fuel prices.

"Unfortunately, despite the return to profitability this quarter, we've got to acknowledge that our challenges remain great," Gerard J. Arpey, the chairman, president and chief executive officer of AMR, said on a conference call following the release of the earnings data. "While I am pleased with our performance this quarter, I recognize that second-quarter profitability must be much higher if we are to return our company to a position of financial strength."

In the second quarter ended June 30, AMR - the Fort Worth, Tex.-based corporate parent of the largest U.S.-based carrier, American Airlines - posted a net profit of $58 million (30 cents per fully diluted share) - well up from its year-earlier earnings of $6 million (three cents per share), which included a $31 million benefit from special items. The latest quarter was AMR's first profitable quarter, without the benefit of special items, since the fourth quarter of 2000.

Arpey said that a big part of the credit for the improvement must go to the company's efforts to cut costs. It was able to reduce its mainline unit costs - i.e. just its core American Airlines operation, not including its smaller regional carriers - by 4.3% year-over-year, excluding fuel costs and special items.

"At the start of the year, I think we shared with you that we had identified over $700 million in annual cost savings initiatives, and we incorporated those anticipated savings into our 2005 budget," the AMR CEO said. "Since then, we have pinpointed another $65 million in expected annual savings and we are, of course, still working to find more."

At Houston-based Continental, operator of the fifth-largest U.S. carrier, second quarter net income hit $100 million ($1.26 per diluted share), although this included a $47 million gain related to the contribution of ExpressJet shares to Continental's defined-benefit pension plan during the quarter. Excluding that unusual gain, Continental recorded net income of $53 million (69 cents per share) - a sharp turnaround from its year-ago loss of $28 million (43 cents per share). The latest per-share earnings easily topped the 20 cents consensus of a number of Wall Street analysts.

As is the case with American, Continental has been aggressively trying to cut its costs - knowing that it is in a race against ever escalating fuel prices. For instance, the company implemented pay and benefit reductions for most of its work groups in April and said that it expects to achieve approximately $418 million of annualized savings from these pay and benefit reductions and work rule changes when fully implemented.

However, as Continental's chief financial officer, Jeff Misner, ruefully noted during the company's conference call, "unfortunately, all of our efforts have been overwhelmed by the rising cost of fuel."

He noted that jet fuel prices having peaked at over $70 per barrel during the quarter, "with fuel at this level and in a tough domestic fare environment, even with recent fare increases, we still expect to have a substantial loss for this year."

Quarterly fuel costs just for the mainline operations increased by $188 million year-over-year, and by $237 million including the regional operations. Fuel costs per gallon during the quarter, including taxes, averaged $1.6695, up 47% from a year ago - and that is likely to worsen in the current third quarter, with Continental projecting an average cost per gallon of $1.82, up 52% year-over year.

Misner said that Continental has no fuel hedges in place, so instead, "we continue to work several fuel-burning initiatives," including having installed winglets on 43 of its 737 next-generation aircraft and four of its 757-200 aircraft, a measure which helps cut fuel consumption by about 4% when the craft is airborne.

Fuel efficiency seen as solution

Continental's chairman and CEO, Larry Kellner, said that hedging is, at best, "a short-term solution" to airlines' fuel problems. "The only long-term solution is to be as fuel-efficient as possible," which he said Continental was doing naturally by having a relatively young, fuel-efficient fleet rather than flying older gas guzzlers, by installing the winglets, and having its pilots take other measures to limit excess fuel consumption.

While recent industry moves to raise fares to bring them more in line with escalating fuel prices have helped a little - such as Delta Air Lines Inc.'s recent partial raising of its previously announced caps on many kinds of fares, a step quickly matched by Continental and other competitors - Continental's president, Jeff Smisek, said "I'd classify [such increases] as pricing towards fuel [prices], not pricing to fuel."

At AMR, CFO James Beer noted that second-quarter fuel costs averaged $1.64 a gallon, a 47% gain year-over-year. The company's hedged position was "diminutive." Looking ahead, AMR sees its average fuel price hitting $1.85 in the third quarter, for $1.5 billion in quarterly fuel costs, a 47% gain year-over-year. AMR has only "limited" hedges in place for the third quarter, and is 8% hedged at $47 per barrel for the fourth quarter. For the full year, AMR projects an average fuel price of $1.72 per gallon.

Like their counterparts at Continental, AMR's planners and pilots are trying to stretch those precious fuel dollars as far as they can.

"If there's any silver lining to high oil prices," Beer said, "it's that we've developed a variety of ways to reduce our fuel consumption." He noted that with AMR's capacity up 3.4%, "and record load factors adding weight to our planes, one would expect greater fuel consumption - yet our second-quarter consumption actually declined slightly year-over-year."

Plenty of cash

High fuel prices have put such cash-strapped competitors as Delta Air Lines Inc. and Northwest Airlines Corp. on the ropes, with the chief executives of both companies recently warning that bankruptcy filings could not be ruled out - but such liquidity concerns do not bother Continental and AMR.

Beer said that AMR ends the quarter with $3.9 billion of cash and short-term investments. Restricted cash stood at $492 million. The company has total debt of about $20 billion.

Continental, Misner said, ended the second quarter with just over $2 billion of cash and short-term investments, excluding $241 million of restricted cash.

That liquidity cushion includes the proceeds of a $350 million loan facility the company closed on during the quarter, consisting of two term loans secured by Continental's wholly owned subsidiaries Air Micronesia and CMI, route authorities and some related assets. Misner said that the company took out the loan in order to have the funds on hand to repay the $200 million of debt coming due in December - the company's 8% notes due Dec. 15 - and to make a pension fund contribution without dipping into its cash reserves for those purposes. The company expects to have between $1.9 billion and $2 billion of cash and short-term investments on hand by the end of the third quarter, and will end the year with $1.5 billion in the till. Those numbers envision no additional financing beyond that required for aircraft deliveries.

Continental has total debt and capital leases of $6 billion, of which $5.7 billion is debt. $581 million of that is current and due in the next 12 months.

While Continental and AMR seem at this point unlikely to follow the recent examples of such airlines that have crash landed in the bankruptcy courts over the past several years, such as UAL Corp.'s major unit, United Airlines, US Airways Group - bankrupt for a second time - and ATA Airlines - CEO Kellner, looking at some of his weaker competitors, said, without naming any names, that "we may see one or two more [airline bankruptcies before the current cycle runs its course]. This may have some effects on capacity, since airlines in Chapter 11 sometimes cut capacity. But I don't believe that anyone is going to just go away."

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