British Airways has announced it will cut its capital spending this year by another 20% to 580 million pounds. It is in the process of negotiating with its unions to significantly reduce jobs.  Sharp drops in premium class fliers, a large source of profits, are pressuring the airline financially.

The importance of this news is that BA is not only one of the largest airlines in the world; it is a firm that shares many of the same destinations as major American carriers especially United (UAUA), Delta (DAL), and American (AMR).  The dynamics of the BA P&L are not terribly different from those of its US peers. Fuel prices are moving up at the same time that demand for seats is dropping.

A number of economists believe that, even if some sectors of the economy such as housing and the financial system recover, consumers and businesses will hew to a strict austerity, the hallmarks of which will be a desire to cut leverage and preserve capital. These habits may become a pillar of the new economy which makes them a danger to the financial health of the airline industry for the foreseeable future.

TheStreet.com recently reported that “Airlines are trading as if headed for bankruptcy this year,” Avondale Partners analyst Bob McAdoo wrote.

The stock market is voting that AMR and United are unlikely to make it through the year without a crisis. Shares in United are down 70% and American’s are down more than 60%. There is a very reasonable chance that there will be no recovery in passenger traffic or reduction in jet fuel prices between now and a year from now.

The federal government will probably have to quickly clear the way for one or more airline mergers and some federal funding, perhaps in the form of low-cost loans, to keep the industry from several bankruptcies. Chapter 11 filings are likely to crush a large group of creditors, a reprise of what happened as the car companies went through restructurings. The point will come when many banks and investment firms will have booked such large losses on bankruptcies that their own futures will be in doubt.

Congress and the Administration will be under pressure to save the airlines for a number of reasons.   The most important one is that the airline industry is among the largest employers in the country. Hundreds of thousands of jobs are at risk when the employees at the airline suppliers are added.  The industry is now facing its worst crisis since 9/11. The important difference is that it is hard to see an end point to the current troubles. Business frugality and dampened consumer spending could go on for years. Airline capacity, as it exists today, could still be much, much greater than demand even though there were sharp cuts across most carriers last year.

Portions of the airline industry are about to collapse, leaving only the question of what the government, already financially limited in its  borrowing ability, will do to resolve this crisis.

Douglas A. McIntyre

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