Low-cost AirTran hits a dry patch

AirTran Airways built a 2008 business plan based on oil at $90 a barrel. So the recent spike in crude above $100 has created what AirTran Board Chairman Joe Leonard calls a "tough" and "scary" year for the entire airline industry.

But Leonard argues that the Orlando-based low-fare carrier, which turned a $53 million profit last year, is better positioned than many of its competitors to survive the heavy fuel-price burden. He emphasized that AirTran has a new, fuel-efficient fleet, the lowest operating cost in the industry and a large portion of its fuel hedged against high prices.

AirTran and Delta Air Lines have their major hub operations at Atlanta's airport and Leonard is a former Northwest Airlines executive, which puts him in a unique position to observe the on-again, off-again merger talks between Delta and Northwest. Since their pilot groups deadlocked over seniority issues, Northwest and Delta are focused on coping with high oil prices before they make any big move toward consolidation.

In a wide-ranging interview in St. Paul, Leonard said: "It looks like, after a very brief respite, that the industry is back into huge losses again."

AirTran has responded by slowing its growth rate to 8 percent or less, selling two Boeing 737s and dropping unprofitable routes -- including its Twin Cities to Chicago Midway service.

Terry Trippler, a Minneapolis-based fare expert, said the AirTran service, which began in 2005, ensured affordable fares because Northwest matched them. But now that AirTran is exiting the market, ticket prices are expected to rise because it would be difficult for another low-fare airline to profitably serve that route.

Leonard said that the Twin Cities-Chicago route "never has performed very well." He explained that "Northwest and United were matching the Midway fares" on their service to Chicago's O'Hare Airport. So AirTran was unable to secure a fare advantage that could have boosted passenger demand.

AirTran, which had total revenue of $2.3 billion in 2007, is a growing airline and it has continued to make inroads in Atlanta. Delta had 71.8 percent of the Atlanta market in 2007 compared with 19.3 percent for AirTran. Back in 2000, AirTran's market share was 9.1 percent, according to a Credit Suisse study.

AirTran's fleet of 87 Boeing 717s and 52 Boeing 737s has an average age of three years, which Leonard said is helping to conserve fuel at a time of record oil prices.

Lowest costs flying

AirTran and Southwest Airlines -- the nation's largest low-fare airline -- have the lowest unit costs among the big network and low-fare carriers. Although major airlines, such as Northwest and Delta, slashed their costs in bankruptcy, there is still a gap between the low-fare airlines and big six airlines. For example, excluding fuel costs, AirTran and Southwest spent 4.7 cents per seat mile in 2007 to operate. Northwest's comparable unit cost was 7.7 cents, while United Airlines was at 9.4 cents. The big airlines carry more overhead to support far-flung international operations and historically have had higher labor costs.

Most of the major airlines have hedged just a fraction of their fuel supplies for 2008.

At a J.P. Morgan conference last week, AirTran reported that it had hedged 40 percent of its 2008 fuel for the first quarter, and 41 percent, 35 percent and 29 percent for the remaining three quarters.

AirTran recently was paying more than $3.25 per gallon for jet fuel. After the effects of hedging are realized, the carrier expects its first-quarter price for fuel to be between $2.95 and $3 per gallon.

If AirTran's combination of hedges and market prices can yield the equivalent of oil at $90 a barrel this year, Leonard said that AirTran could make money in 2008. But he said profitability "gets iffy" when oil exceeds that $90 level.

UBS analyst Kevin Crissey predicted last week that AirTran will lose 57 cents a share in 2008. J.P. Morgan's Jamie Baker recently predicted a loss of 40 cents a share.

AirTran has been on a rapid growth trajectory. The carrier grew by 19.4 percent last year. After slowing to about 8 percent growth this year, the carrier expects to expand at the rate of 5 percent in 2009.

But Leonard doesn't expect to be idle. The Georgia native said he was looking at office space in downtown Minneapolis last week, and he plans to work as a consultant and serve on more boards of directors.

Outbid for Midwest Airlines

Last year, Leonard spent considerable energy attempting to acquire Milwaukee-based Midwest Airlines. Ultimately, AirTran was outbid by a partnership consisting of TPG Capital, a private equity firm, and Northwest Airlines. They closed on the transaction early this year.

Leonard said that he thinks it's ironic that Northwest and its partner "paid $453 million for something that was probably worth $125 million at the date of closing, in order to try to keep us out of Milwaukee."

By this summer, AirTran will be serving 15 cities from Milwaukee. "We've already announced LaGuardia and Washington National, which are their two most profitable routes," Leonard said. "So all of the effort and all of the hubbub to try to keep us out of Milwaukee was for naught."

"Our strategy for doing so was our code-sharing agreement with Midwest, which would have been lost if AirTran had completed its acquisition of Midwest," Hirst said, noting that Northwest recognized that AirTran could expand in Milwaukee because extra gates were available.

"It is a competitive marketplace and AirTran is free to compete wherever they like," Hirst said.