Rising Costs Expected To Trim Airline Profits Higher Wages, Increased Maintenance Contribute To Slower Growth

UAL Corp. and AMR Corp, the two biggest U.S. airlines, said they expect costs to rise by as much as 3 percent this year, faster than last year, reflecting higher wages and increased maintenance as planes age.

The escalating costs, which exclude fuel prices, could signal that airline profits will increase at a slower rate this year, according to analysts addressing a group of banks and aircraft financing companies last month at the Financing Opportunities Symposium in San Francisco. Industrywide costs rose between 1.5 percent and 2.5 percent last year, estimated Ray Neidl, managing director at Furman Selz/ING Barings.

The possibility of slower revenue growth and higher capacity - defined as available seats - also could slow profit growth this year, said Barry Boothe, managing director of D’Accord Financial Services Inc., which finds investors to back airplane leases.

No one was suggesting that airlines are in trouble, though the tone contrasted with the record earnings reports from the major airlines over the last few weeks.

“The airlines are at such high levels of profitability that they can afford to have some reduction in profits and still be quite strong,” Boothe said.

Airline profits in the fourth quarter rose from 50 percent at some carriers to as much as threefold and fourfold at others. The airlines made more money last year than they have in industry history. Industry operating profit is expected to reach $7.8 billion in 1997, up 25 percent from $6.25 billion in 1996, said Ed Starkman, director of equity research at SBC Warburg Dillon Read Inc. He sees industry profit rising about 6 percent this year to $8.3 billion.

Continental Airlines Inc. expects its labor costs to rise by $100 million this year, said Gerald Laderman, vice president of corporate finance at the Houston-based airline. The company plans to offset the higher expenses with “cost initiatives,” he said, citing plans to lower interest payments by refinancing some debt and boosting sales by attracting more high-paying customers such as business travelers.

Starkman isn’t convinced and rates the stock a “neutral.”

“They have a powerful revenue story,” Starkman said. “But it’s very clear that their unit costs are going to be going higher. They think $100 million in cost savings will make up for the higher labor costs, but they haven’t pinpointed the savings.”

Laderman declined to say how high Continental’s costs would rise this year, though he said he expected a 2 percent to 3 percent increase industrywide. Northwest Airlines Corp.’s managing director of corporate finance, Jeff McDougle, agreed. Northwest, the fourth-largest U.S. airline, recently agreed to buy a 14 percent stake in No. 5 Continental for about $519 million in cash and stock.

Likewise, UAL, parent of United Airlines and the second-largest airline company based on revenue, expects costs to increase 3 percent in 1998, said Thomas Mutryn, vice president and treasurer of the Chicago-based company.

Expenses will increase by more than $200 million, reflecting in part a new agreement to raise flight attendants’ pay by 36 percent over the next five years and a scheduled 5 percent company-wide wage increase that was part of the 1994 employee buyout agreement that exchanged 55 percent ownership for wage concessions.

United also expects higher maintenance costs this year, Mutryn said. The airline is at the beginning of a plan to replace its older planes, which require much maintenance, with newer planes.

Nonetheless, Mutryn said he expects 1998 to be “another strong year” fueled by a strong U.S. economy and United’s expansion into Latin America.

“We’re very comfortable with the situation we’re facing in the U.S. and worldwide in 1998,” Mutryn said. “We have strong domestic and Latin American markets that will help us overcome some of the weakness in Asia and help temper earnings fluctuations.”

UAL reported that its fourth-quarter profit rose 63 percent as it benefited from heavy passenger traffic, higher fares and lower fuel prices.