In Air France/KLM Results, a Foreshadowing of Airline Trouble

The International Air Transport Association (IATA), the global airline industry association, warned in its annual forecast that the economy could hurt earnings of carriers around the world in 2012, particularly in Europe. The group said very little about fuel costs as a challenge. That was a mistake.

Air France/KLM, one of the world’s largest carriers, posted an 809 million euro loss ($1 billion) in 2011 and said that results for the first half of this year would be worse. The company believes its fuel costs will rise by as much as 1.1 billion euros.

The news is a stark reminder that the airline industry could fall into the kind of trouble it experienced in 2008 as high fuel prices and low ticket sales, undermined by the recession, caused billions of dollars in losses. The results eventually prompted carriers to consolidate. The largest marriages were those between Northwest and Delta and between United and Continental.

The stocks of the major U.S. airlines do not yet reflect the coming trouble. Shares of US Airways (NYSE: LCC), which was not part of the M&A activity of the past three years, trade at $7. That is well above their 52-week low of $3.96. Southwest Airlines’ (NYSE: LUV) stock has traded in a similar pattern. It is another carrier not involved in any major M&A activity. The new conglomerate, United Continental (NYSE: UAL), also trades well off its 52-week bottom.

The movement in the price of jet fuel is not terribly different from that of gasoline. Jet fuel prices have jumped higher quickly. With West Texas Intermediate crude well above $100 and with no sign of a drop, the airline industry fuel bill will be colossal this year. Carriers will have to brace for losses that could be the largest in years. In the past, the way out of this kind of trouble has been through Chapter 11, a route that AMR recently took because of high costs and a poor balance sheet. United Continental and Delta (NYSE: DAL) improved their finances via mergers, but big fuel bills will catch up to them as well.

Air France/KLM results are a warning to the balance of the industry that 2012 will be a brutal year for earnings.

Douglas A. McIntyre