Fuel hike might ground ATA plan: Fleet-cut savings nearly wiped out

September 5, 2005

On the expenses line of ATA Airlines Inc.'s battered books, the savings associated with a fleet reduction might have been accounted for as a tailwind that accelerated its flight to financial solvency.

Paring 35 of its 82 aircraft in the first half of this year saved the Indianapolis carrier $49 million in jet fuel and oil expenses. That's big money for the bankrupt airline: half of what it's trying to raise from investors to pull out of Chapter 11 and dwarfing the $38 million in extra concessions it wants from pilots.

But soaring jet fuel prices added $46 million to ATA's expenses in the first six months of this year--erasing nearly all the fuel savings from its dramatic fleet reduction.

With fuel prices climbing higher after Hurricane Katrina's disruption of gulf oil production, some analysts now see ATA flying in the direction of the perfect storm, one that could delay the filing of a reorganization plan this year and make it less attractive to investors needed to keep it aloft.

"With the worst year to come in fuel prices, it remains to be seen whether any airline can make it out of bankruptcy," said Michael Miller, a partner of Washington, D.C., aviation consulting firm Velocity Group.

"It's going to be hard for ATA to confirm a plan [of reorganization] before the end of the year. With the spike in oil prices, it's another straw on the camel's back, a tremendous pressure on cash flow. It could be catastrophic for the reorganization effort," said a member of a professional services firm involved in the ATA bankruptcy, who spoke on the condition of anonymity.

Fuel-about 20 percent of an airline's expenses-isn't the only cloud on ATA's horizon:

* Deeper year-end travel slump?

Some leisure travelers might cut back on flights as each fill-up at the gas station climbs.

"That's $40 I don't have to take the kids to Disney World," said Evergreen, Colo.-based aviation analyst Michael Boyd.

* Possible flight disruptions. Longsuffering cockpit crews are now exasperated by ATA's attempt in court last month to void their contract with the Air Line Pilots Association, and by a request for $38 million in new concessions on top of the $66 million over the last 14 months. A strike vote began last week and ends Sept. 12.

"I don't know if [the rising jet fuel price] hurts our leverage, but it has not weakened our resolve," said Rusty Ayers, an ALPA official in Chicago.

* Declining cash reserves. Available cash is forecast to fall from roughly $63 million today to $43.7 million by the end of this month, due mostly to reorganization costs. That cash also secures a bailout loan the Air Transportation Stabilization Board guaranteed ATA after the 2001 terrorist attacks. If the cash balance falls below $29 million, the ATSB and lenders could pounce and ATA could lose access to critical cash it needs to survive.

Airsick investors? Under terms of a $40 million loan Southwest Airlines made to ATA, and as a condition to secure $30 million in equity investment from the Dallas carrier, ATA must file its plan of reorganization by Dec. 31. Will Southwest agree to an extension if the deadline for a reorganization plan passes?

"One of the likely questions that Southwest has got to be pondering is, how distressed is ATA vs. when they made the investment in the carrier? Things have changed quite dramatically," said Velocity Group's Miller.

ATA also is buttonholing the investment community for $100 million in financing. At June 30, ATA estimated it needs $50 million in additional funds "to provide the liquidity necessary to continue as a going concern through the end of 2005."

But the soaring cost of jet fuel "is certainly going to decrease the possibility that those already in Chapter 11 will find exit financing... I'm not sure how easy it will be for them to find investors," said Morningstar analyst Chris Lozier.

Clearly, ATA is under extreme pressure over the next few months, although ATA executives downplay the impact of stratospheric jet fuel prices.

"Higher fuel prices obviously impact our operating costs, but we are fortunate to do about a third of our business in contract flying, where we can pass through higher prices," said Sean Frick, chief restructuring officer and vice president of strategic planning for ATA.

Frick is referring to ATA's contracts to fly passengers for the U.S. military, which amounted to 36 percent of ATA's revenue in the second quarter, a fortuitous rise from 17 percent in the same period last year.

While ATA effectively is hedged against fuel costs on military contracts, it has no fuel hedging on its core business of scheduled airline service. Compare that with perennially profitable Southwest, which for years has bought fuel in advance at lockedin prices. Such hedging saved the Dallas carrier $196 million in the second quarter, according to Morgan Stanley Research.

For Southwest, fuel represented 1.55 cents per available seat mile during the second quarter, vs. 2.35 cents for ATA. Analysts said ATA and many other airlines are far too battered now to afford to hedge their fuel costs. Even when times were good for ATA in 2000, when it signed ill-fated leases on larger versions of the Boeing 737, "They never really had enough of a window when they had enough cash lying around" to hedge, Ayers said.

High fuel expenses or not, "We have not changed our previously announced target of emerging from Chapter 11 in 2006," ATA's Frick added.

But what then? Industry guru Boyd said ATA's woes might betray a crack in the armor of the low-cost carrier model, which has largely targeted the leisure passenger.

Large, so-called legacy carriers have broader revenue streams such as the business passenger. Nor do low-cost carriers serve a number of midsize and small cities that are emerging as lucrative markets, Boyd said.

"It might make the ATA model uneconomical if oil stays at $70 a barrel. The large carriers have a much wider revenue stream," he said.

Then again, no one is quite sure what ATA's business model will be until it files its reorganization plan. Several analysts warn that ATA shouldn't stake its future on Southwest, with which ATA has a codesharing agreement that allows it to collect money flying Southwest passengers on routes the Dallas carrier doesn't serve, such as Las Vegas-to-Hawaii, and vice versa.

Southwest, which snapped up six of ATA's gates at Chicago Midway Airport, estimates its code-sharing deal with ATA could fetch it $50 million a year.

But one analyst who asked not to be named said that's pocket change for Southwest, which doesn't need the ATA distraction as it focuses on problems in the Northeast.

"They don't give a rip whether ATA lives or dies," he said.

"Southwest may decide that it doesn't want to participate anymore with ATA," said analyst Miller.

Code sharing has been so profitable that the airlines have expanded it, according to Southwest spokeswoman Melanie Jones.

"We're keeping a really close eye on how [ATA is] doing and we are pleased with the financial success that we've gained from the code sharing," Jones said.

An ATA spokesperson said Southwest "has expressed satisfaction with its [codesharing] success thus far and the agreement has proven beneficial to both airlines. This is demonstrated by the fact that we have already exceeded originally forecasted volumes."

Another bright side for ATA might be if the airlines finally agree in unison to pass on more of their fuel costs to passengers, said Morningstar's Lozier, noting that ATA is not alone in dealing with the fuel burden.

The trouble, Boyd said, is that "fuel prices going up is going to put the squeeze on carriers with the weakest revenue streams."
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