The auto sector comes close, especially companies like GM, Ford, and Chrysler that depend heavily on truck sales. But at least auto companies can change their mix of vehicles to adapt to high gas prices. They may not be able to sidestep all the pain of high gas prices, but at least they have options.

So what options do the airlines have? They’ve already cut costs to the bone. And from the feedback I’ve received, it seems like they’ve royally pissed off passengers and employees alike.

IDE reader, Wayne said I shouldn’t be pointing the finger at unions or the costs of legacy benefits: “…most U.S. legacy carrier employees have had their incomes slashed by at least 40% and have either watched as their pensions were frozen or dissolved.  Along with the pay cuts, premiums on health care doubled, work rules returned to the dark ages, and even crew meals were eliminated.”

Sadly, Wayne is right. Employees have taken it on the chin.

But other readers say it’s the passengers who are taking it on the chin. Jean-Antoine, for one, resents how passengers are being treated. He says, “whilst we are being asked to pay (and it’s only normal) for our transportation costs, we are treated like rotten meat. Some one or two decades ago the airlines were going out of their way to make you feel happy to board an airplane. Nowadays you are being engulfed in huge airports where nobody can give you proper directions… where the personnel is overworked, most of the time disagreeable and often not concerned…”

Harsh words from Jean-Antoine but he wasn’t the only one who took this view. Can anybody disagree that there’s been a sharp deterioration of services? It’s pretty clear that customers don’t get the attention, food, and friendly service they used to get.

Just yesterday, United announced it’s going to ground 94 (64 in addition to the 30 previously stated) 737 jets, plus some of its bigger 747’s. What’s more, they’re expected to announce more employee reductions on top of the 500 they’ve already said they would cut.

Airlines have disaffected their two most important constituencies: employees and customers, and what do they have to show for it? Not much. Their collective backs are still up against the wall…

The question is: can they do anything now to avoid downsizing?

Hubs are expensive to maintain. Can they simply drop some of their money-losing hubs? Can they go further and adopt the low-cost carrier model?

The big problem with this line of thinking is that high fuel prices are sabotaging the profits of the low-cost carries too.

Whether legacy or low-cost, you can’t fill half or three quarters of a plane with people at 1988 prices, have it run on jet fuel that costs $161 a barrel, and make money.

The reality is that lots of low-cost airlines have also struggled. In the past six months, at least a dozen airlines have failed as oil rose. American companies ATA, Frontier, Skybus and Aloha Airlines have all filed for chapter 11 bankruptcy protection this year.

In all, about two dozen low-cost carriers and other non-legacy carriers have filed for bankruptcy or gone out of business since 2000.

But listen, retailers, restaurants, high tech and industrial manufacturers fail all the time. The airline industry has simply proved not to be the exception. And higher fuel prices are sure to increase the rate of failure (or bankruptcy) in this sector.

As Stephen Ridgeway, the chief executive of Virgin Atlantic Airways, recently said, “The good times are over.”

Let the downsizing begin. Only then can supply and demand rebalance and ticket prices start to rise. There’s no other cure.

Good Trading,
Andrew Gordon

P.S.  To let me know what you thought of today’s article, send an e-mail to: feedback@investorsdailyedge.com.

Source: Airing It Out

Continental’s management ended months of speculation by announcing that a merger with troubled United would do more harm than good, even with the intense pressure airlines are under due to record high oil prices and the competitive threat posed by the recent deal between Delta Air Lines Inc. (DAL) and Northwest Airlines Corp. (NWA).

“The risks of a merger at this time outweigh the potential rewards,” Chief Executive Officer Larry Kellner said in a letter. “While some would prefer to see Continental pursue a merger, we strongly believe we have made the right decision.”

As for the niche carrier Eos, in grounding itself it joins Skybus Airlines, Aloha Airgroup Inc.’s Aloha Airlines and ATA Airlines Inc., which have already ceased operations, as well as U.S. charter operator Champion Airlines, which announced plans to stop flying at the end of May.

Frontier Airlines Holdings Inc. (FRNT) also has filed for bankruptcy protection, but at this time plans to keep flying.

The Eos downfall was “no surprise,” Calyon Securities airline analyst Ray Neidl told The Associated Press. “We saw it happen with other smaller, undercapitalized airlines. Basically, there are too many airlines. We’re in a period of consolidation. The weaker guys, [facing] $120-a-barrel oil, are finally succumbing.”

With jet fuel the single largest expense for carriers, merging to capitalize on economies of scale makes sense. And as the world’s new largest carrier, the Delta/Northwest merger now has the competitive advantage.

But while Continental still might be able to go it alone – even against a stronger potential rival – United is in a much weaker financial position and needs a partner. The carrier wasted no time in turning its attentions to U.S. Airways Group Inc. (LCC).

“Consolidation is under way – ensuring you have the right partner is everything,” United Airlines Chief Executive Glenn Tilton said in a statement. “We will pursue all options to ensure a strong, sustainable future for our airline.”

While talks with U.S. Airways are not yet at the advanced stage United had reached with Continental, management is doing its best to accelerate discussions, hoping to finalize any deal before the end of the year – and before there’s a possible change in the political party in the White House.

When it comes to mega-mergers – and industry consolidations in which there might be a perceived decline in competition – the Bush administration is seen as being more of a proponent for deals that require Justice Department approval in order to proceed.

Analysts say that U.S. Airways and United could mesh well due to similar pay structures and complementary fleets. In addition, United and U.S. Airways are both members of the Star global marketing alliance.

Bigger is Better

Atlanta-based Delta announced it would buy the Eagan, Minn.-based Northwest for $3.63 billion, all in stock, creating a single carrier with a combined enterprise value of $17.7 billion.

Delta Chief Executive Richard Anderson will be chief executive officer of the combined company. Delta Chairman Daniel A. Carp will become chairman of the new Board of Directors.

The carriers decided to go ahead with a merger despite being their respective pilot’s unions being unable to come to agreement. Delta’s 7,000 pilots endorsed the deal by supporting a new labor agreement that includes an equity stake.

While Northwest’s 5,000 pilots will be asked to join a contract before the deal closes, the union is expected to oppose deal after the unions could not agree on how to assign pilot seniority – a key determinant of shifts, pay scale and what airplanes they fly – in the new organization.

It is expected that the Delta/Northwest merger will be approved later this year.

The troubled airline industry has been beset by a host of problems on all sides as rising oil prices and a weakening U.S. economy have combined to take a big bite out of the carriers’ bottom lines. At the same time, efforts to increase cost efficiencies through mergers have been blocked by labor unions.

Airlines looked like they were battling back from a five-year slump following the 9/11 terrorist attacks, a period in which carriers rolled up $35 billion in losses. But while demand for air travel remains high, passenger satisfaction is at a historic low. Operational performance, which includes everything from on-time arrival to lost luggage, is at its lowest point in 20 years, according to the latest Airline Quality Rating study. “With the U.S. airline industry at rock-bottom in terms of overall performance, greater accountability is necessary,” said Brent Bowen, a researcher on the study who’s with the University of Nebraska at Omaha.

Airlines are searching for ways to cut costs without adding to the already unpopular passenger charges and fees, especially as consumer spending wanes. Fuel is the biggest expense category for airlines, and with oil north of $100 a barrel and heading higher, consolidating to capitalize on economies of scale seems to make sense.

Although a number of deals have been proposed, none have really been able to get off the ground.

Stalled U.S. Airline Merger

Delta Air Lines Inc. (DAL) and Northwest Airlines Corp. (NWA) have been in merger talks for months now. Several important issues have already been decided. The combined carrier will fly under the Delta name and will be based in Delta’s home city of Atlanta.

Delta Chief Executive Officer Richard H. Anderson will remain on as head. But the stumbling block in a deal that would create the largest domestic carrier is the endorsement of the pilots.

In the past, airlines have had the pilots hammer out a deal after a contract has been signed. But hoping to have a fully functional combined airline that much sooner, Delta and Northwest encouraged their pilots to negotiate as soon as the planned merger was announced.

Unfortunately, the extra time hasn’t helped. The two unions have been unable to come to an agreement on seniority, which affects pay as well as route selection and the types of aircraft flown for the 12,000 pilots involved in the merger.

Without an agreement, the two unions have refused to endorse the merger.

Labor union support is critical to any merger, as Delta’s pilots’ union was instrumental in derailing a hostile bid takeover by U.S. Airways Group Inc. (LCC). But without the merger, Delta and Northwest will be forced to implement other cost-saving measures, including raising fees and cutting jobs.

UAL Corp.’s (UAUA) United Airlines and Continental Airlines Inc. (CAL) had also started merger talks earlier this year, but negotiations are on pause as the two airlines are waiting to see what happens with Delta and Northwest, a source with knowledge of the matter told Reuters.

European Merger Woes

Meanwhile, across the pond, Franco-Dutch carrier Air France-KLM (OTC: AFLYY) is facing similar labor opposition to its buyout of Italian carrier Alitalia – Linee Aeree Italiane S.p A.

Alitalia recently suspended trading of its shares and is estimated to be losing almost $1.5 million (the equivalent of 1.0 million euro) a day. The struggling carrier desperately needs the merger to go through in order to survive. Without a much-needed capital infusion from Air France-KLM, the carrier will undoubtedly have to file for bankruptcy protection.

But unions failed to approve the Air France-KLM bid, which included a 10% staff reduction, a $1 billion capital infusion and an all-stock bid that valued Alitalia at $217.7 million (138 million euros).

Air France-KLM said on Monday this was “the only plan able to allow Alitalia to return to health swiftly,” Reuters reported.

The Italian government is eager to divest its share of the financially unsound airline and Economy Minister Tommaso Padoa-Schioppa, the driving force behind the sale, has said unions must make a move fast or risk having the government appoint a special administrator to take over the negotiations.

With Italy’s elections looming on April 13 and 14, the government is eager to find a favorable solution.