Trouble On The Horizon

By Janice Castro

Talk about bad timing. Just last week officials at Continental Airlines proudly unveiled new interior designs for their aircraft. But the spectacle of the troubled carrier showing off its blue-and-gray fabrics and contoured seating reminded airline experts of the old line about rearranging the deck chairs on the Titanic. Just a week earlier the airline had veered away from a return trip to Chapter 11 bankruptcy protection, from which it had emerged four years ago. Instead Continental may try to raise cash by selling off some of its valuable routes and other assets. Like many of its competitors, Continental has been caught in a powerful economic downdraft at a time when the airline was expanding and ill-prepared for trouble.

No industry is being hit harder by gushing crude prices than the airlines. Loaded with debt after a string of mergers, takeovers and multibillion-dollar orders for new aircraft, U.S. carriers are reeling under the one-two punch of explosive fuel costs and a recessionary slowdown in air travel. Says Stephen Wolf, head of United Airlines: "Fourth-quarter projections for the industry are nothing short of alarming."

Fuel prices have run up faster than ever before. After Iraq invaded Kuwait, jet-fuel prices more than doubled, to $1.46 per gal., before settling last week at $1.04. The U.S. airline industry consumes at least 15 billion gallons of jet fuel annually, which means that every 1 cents increase in fuel prices will increase total operating costs by $150 million. The results are devastating. U.S. carriers expect to lose $1.2 billion during the October to December period alone, more than the industry has ever lost in an entire year. Aiming to ride out the crisis, airlines are slashing costs, scrimping on fuel and cutting service. They have laid off more than 8,000 workers (1.6% of their labor force), with more to come. They have set up special conservation committees to find ways to save jet fuel and have parked dozens of aging gas guzzlers on the tarmac.

Travelers will ultimately suffer from the cutbacks. Some carriers have eliminated flights on their least profitable routes and tightened up on such passenger perks as frequent-flyer programs. To pass along some of the higher fuel expenses, airlines have boosted fares three times since August, by a total of 15.3%. They are likely to do so again in the coming weeks, despite fears that higher fares will drive away the customers. Making matters worse, the government has just slapped the industry with $18.6 billion in airline- ticket taxes and other special levies during the next five years as part of the deficit-reduction deal.

Passenger-traffic growth was anemic for the year even before the gulf crisis erupted. Domestic passenger miles have increased only 2.7% this year, while the foreign business of American carriers has grown 17%. But the airlines are watching a relatively slow year turn into a disaster. The financial outlook: "Stinko," declares Robert Crandall, chief of American Airlines, one of the healthiest carriers. Michael Durham, the airline's chief financial officer, blames the fuel jolt as the No. 1 problem. "There's very little you can do when a commodity that represents 15% to 20% of your total operating costs goes up by almost 100%. It's a very difficult time to make money."

The flurry of financial blows has knocked the stuffing out of an industry that made a record $1.7 billion in profits in 1988. After a wrenching consolidation during the '80s that forced over 200 carriers to merge or disappear, the few remaining major companies are about to undergo another shake-out. Already wobbling badly, a couple of the weakest ones -- Pan Am and Eastern -- may disappear. Others, like TWA and Continental, may be forced to merge with stronger partners or shrink down to a more manageable size.

Once America's flagship carrier, Pan Am has lost $2 billion over the past decade. After two fruitless years of seeking a buyer or merger partner, the airline has begun to raise cash by selling off its prize assets: international routes. Last month the carrier agreed to sell its U.S.-to-London routes to United for $400 million. Still trying to sell off its Northeastern shuttle, Pan Am is fast running out of marketable assets.

Eastern is trying to survive by offering upscale service at coach prices. Since September, Eastern has managed to fill some empty seats by offering free upgrades to first class, but that is not enough to steer it out of bankruptcy. Besides losses of $1 million a day, the carrier has been socked lately with an additional $1 million in daily fuel costs.

Continental was particularly ill-prepared to weather the downturn. The carrier accumulated more than $2 billion in long-term debt in the process of building itself into one of the five largest U.S. carriers. Rival carrier Delta confirmed last week that it may buy some of Continental's assets. At TWA, market share has slipped from about 10% in 1985 to 8% currently. Since TWA boss Carl Icahn failed to move quickly enough to replace his aging aircraft, the airline is stuck with a fleet that is particularly thirsty and costly. New Boeing and McDonnell Douglas passenger jets are as much as 25% more fuel efficient than the older 747s and DC-9s that fill TWA's hangars.

Desperate to cut costs, airlines have been scrutinizing their operations from the executive suite to the passenger seat. American has frozen management hiring and halted all nonessential capital spending. USAir has delayed taking delivery of 28 new Boeing jets for three years. Chicago-based Midway is closing down its hub at Philadelphia, which it bought only a year ago from Eastern, and plans to sell its operations there to USAir for $67.5 million. Northwest has trimmed its flight schedule by 24 daily flights, or 2% of its total. Even Phoenix-based America West, one of the fastest-growing U.S. carriers, is cutting some late-night and weekend flights.

Some of the most ingenious cost-cutting measures are those dreamed up by Continental's Fuel Conservation Task Force. Seventeen fuel-guzzling old Series 10 DC-9s and 727-100s have been grounded. Airplanes will taxi out to the runway on one engine instead of two. Airliners parked at the gates will be heated and cooled by ground-based units instead of onboard auxiliary-power systems. Someone even figured out that by removing all those little armrest ashtrays -- since passengers can no longer smoke on domestic trips -- Continental can reduce aircraft weight by 50 lbs. a flight. While that is a minuscule portion of a 737's unloaded weight (70,000 lbs.), it is a painless saving. In all, Continental estimates that the measures will save it tens of thousands of dollars a day.

Even so, the industry is bound to consolidate further. High costs mean that ambitious carriers like USAir, Midway and America West are reining in their plans. A year ago, five airlines -- American, United, Delta, Northwest and Continental -- dominated the top tier of the U.S. industry, accounting for 66.3% of all passenger miles. Because of problems at Continental, that tier may soon shrink to four powerhouses.

As the industry is gradually concentrated in fewer hands, fares will tend to rise. Megacarriers facing less competition are also more likely to drop service to less profitable markets, depriving local residents of affordable transportation choices and hurting regional economies by choking off business travel. Says Christopher Witkowski, executive director of the Washington-based Aviation Consumer Action Project: "Passengers will be paying more for service that is of a decreasing quality." In the long run, the industry will regain its strength. Boeing chairman Frank Shrontz, who enjoys a bird's-eye view of the business, maintains that passenger-traffic growth will average 5% or more for the next 15 years. The bulk of that growth, though, is likely to be carried by the Big Four.

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CREDIT: [TMFONT 1 d #666666 d {Source: Air Transport Association}]CAPTION: INDUSTRY PROFITS

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CAPTION: JET FUEL

With reporting by Gisela Bolte/Washington and Richard Woodbury/Houston