NEW YORK Major airlines that survived a decade of reorganization through bankruptcy are now facing their biggest test since the September 11, 2001 attacks.
The latest signals from credit markets show default and bankruptcy risk is rising, even after four main carriers -- UAL's United Airlines UAUA.O, US Airways LCC.N, Delta Air Lines Inc (DAL.N) and Northwest Airlines Corp NWA.N -- retooled themselves under Chapter 11 filings this decade.
Those insolvencies already helped slash labor costs, and it will be tough to squeeze out more savings. That could mean a new round of airline bankruptcies may be afoot.
Rising fuel prices, falling consumer demand and the prospect of a U.S. recession threaten to cripple the industry that was just starting to get on its feet before fuel prices soared to record levels, ravaging profits.
U.S. jet fuel prices hit another record over $3.50 a gallon this week, tracking a rally in the cost of crude. Meanwhile, airline shares have plummeted 28 percent this year, hitting all-time lows. However, shares of most major airlines rose today as oil prices fell.
"This is the most perilous time for airlines since September 11," said Vicki Bryan, an airline analyst for Gimme Credit in Houston. "United and USAirways are scrambling, and they could go bankrupt by the end of the year."
UAL lost $537 million in the first quarter and has about $2.9 billion of unrestricted cash in hand.
Another near-term concern is the airlines' ability to comply with bank covenant and loan agreements. Northwest has asked lenders in its $1.2 billion bank loan to do away with fixed-charge coverage ratios in its loan agreement for the next 12 months, according to Reuters Loan Pricing Corp.
United Airlines and American Airlines are at risk of breaching similar lending agreements, said Phil Baggaley, a Standard & Poor's analyst. "A big near-term concern has been compliance with bank covenants," he said.
Jean Medina, a spokeswoman for United, dismissed the prospect of bankruptcy and said the company has $2.9 billion in cash and $3 billion in unencumbered hard assets that it could use as collateral.
"The large losses posted by U.S. airlines this quarter, the forecast for further losses and the recent liquidations and bankruptcies of a number of carriers indicate quite clearly that the U.S. airline industry is in financial turmoil," US Airways Chief Executive Doug Parker said in a statement last month.
A spokeswoman for US Airways also said the company is comfortable with its liquidity position.
Fuel costs on average now make up a third of airline revenue, up from 25 percent a year ago. For some, such as AirTran, rising fuel costs are eating away at nearly half of its revenue, according to company filings.
Airlines are pursuing alliances and mergers as one way to survive and grow.
British Airways BAY.L said on Wednesday it was in discussions with two of its largest U.S. rivals, American Airlines and Continental Airlines (CAL.N), which a source briefed on the matter said was about a potential alliance.
Large carriers and low-cost carriers alike are feeling the pinch from higher fuel costs.
A slew of smaller carriers including Eos Airlines, Frontier Airlines FRNTQ.PK, Skybus Airlines and ATA Airlines declared bankruptcy in April.
Those bankruptcies may be a warning sign, but so far are only "drops in the ocean," said Roger King, an analyst with CreditSights, a New York-based research firm. "Airlines are in a race to profitability, and no one's winning right now."
King doesn't foresee near-term bankruptcy threats to bigger airlines, but convertible bonds of UAL, parent of United Airlines, for example, are trading at distressed levels of 72 cents on the dollar, with sky-high yields of 19 percent.
US Airways' convertible bonds now trade at about 85 cents to yield almost 15 percent.
Moreover, the real stresses won't come until airlines find out what consumers will pay after demand dips.
"The real solution isn't consolidation, it's raising fares," King said.
UAL's United and US Airways also are in advanced merger talks prompted by Continental Airlines Inc's (CAL.N) decision this weekend to walk away from similar talks with UAL, sources with knowledge of the matter said. Delta Air Lines Inc (DAL.N) also agreed to buy Northwest Airlines Corp NWA.N in an all-stock deal in April.
For investors, potential mergers and long-term trends mean value will be tough to find.
"Airlines have always been something you rent, you don't own," Bryan said. "Short-term, when they are good, you can make some money, but you can lose a whole lot of money long-term and you're going to wear your breakfast for years."