Merger plans grounded, Northwest focuses on survival

A new era of belt-tightening is beginning for Northwest Airlines, as its executives respond to abnormally high fuel costs and craft a future that in the short run isn't predicated on a merger.

The company's planned combination with Delta Air Lines was envisioned as a way to create a global airline that would be a long-term survivor in an intensely competitive industry. Their networks are compatible, with Northwest dominant in Asia and Delta strong in Europe.

But now that merger looks to be on indefinite hold, and with it the vision of building a larger company that could grow its way to greater profits while also being better insulated against cyclical downturns.

Now some analysts are forecasting that most major U.S. airlines will lose money this year, and additional cost savings are tougher to find because a number of carriers -- including Northwest and Delta -- already have restructured themselves in bankruptcy.

While Northwest has the ability to survive on its own, a number of analysts believe it remains a matter of time before a merger is again on the horizon.

And given Northwest's relative size -- No. 5 of the six largest U.S. carriers -- it remains more likely to be acquired than to be the buyer in a merger deal.

Northwest is still formulating changes to its 2008 business plan, but it already has raised fares and built a large cash balance. It is continuing to modernize its fleet with more fuel-efficient planes.

"Northwest is lining up its strategy as a standalone," said Bill Hochmuth, senior research analyst at Thrivent Investment Management in Minneapolis.

A $5.2 billion annual fuel bill?

An evolving part of that strategy is how to deal with much higher fuel prices than management anticipated.

Northwest revealed last week that its fuel bill could reach $5.2 billion this year if oil averages $104 a barrel. That's $800 million more than the carrier projected for 2008, or more than half of the $1.4 billion in annual labor savings that Northwest achieved from its workers during bankruptcy.

A merger with Delta would have helped Northwest employees make up some of that lost ground. Northwest pilots would have received wage increases of more than 30 percent over four years, and it's believed that other work groups were to be offered higher wages as well. However, any new merger overture from Delta could be worth less to workers.

Apparently, some investors are seeing a silver lining in the oil spike.

In a Thursday report, Baker wrote: "A growing number of Delta and Northwest stakeholders have shared with us that they are increasingly relieved the deal that almost was fell through, given the recent spike in crude."

Both airlines "can unilaterally shrink more freely now, then live to revisit a deal as smaller entities with more merger upside down the road," Baker added.

Industry 'really shaken'

Hochmuth agreed that it would be difficult to proceed with a merger now, because the integration costs would be too expensive, given the trend in oil prices and a likely falloff in the number of people choosing to fly. In particular, leisure passengers may reduce their airline ticket purchases in response to recent fare increases, the higher costs for food and gas and diminished confidence about the economy.

In an interview, Leonard said, "This rapid escalation of fuel has really shaken everybody a bit, so people are trying to figure out what they need to do with their businesses." He predicted that "everybody will take a little respite" from merger discussions.

Strong for now

For the foreseeable future, Northwest's financial condition is strong enough to allow the carrier to survive on its own.

Ben Hirst, a Northwest senior vice president, said that Northwest has a cash balance of $3.3 billion, equal to about 25 percent of its total revenue from last year. That gives the airline the strongest relative cash position among the six biggest U.S. airlines.

Northwest "is the best positioned of the network carriers to prosper in a standalone world," Hirst said.

In a Thursday report that analyzed the financial prospects of 10 big airlines, UBS analyst Crissey said "we see every airline except Southwest posting a loss in 2008." He thinks the carriers will cope with high fuel costs through a mixture of flight reductions and increased fares.

Northwest executives are still leaving the door open to a merger.

Hirst said that not only Northwest's fortunes but those of other airlines could be improved with the "right" mergers.

Airline expert Bill Swelbar of the Massachusetts Institute of Technology thinks a merger remains in Northwest's future.

"Despite Northwest's solid financial performance, it is still a relatively small player relative to American, United and Delta," Swelbar said. He added that none of the six largest U.S. airlines is in a position to grow on its own "to the size necessary to compete on a global scale."

Northwest holds a special class of stock in Continental, so it has the ability to block a Continental merger with another rival.

Northwest's Hirst would not discuss any potential merger deals. But Wall Street analysts, airline executives and industry consultants expect that the merger dance will begin anew at some point.