Airlines in grip of big squeeze

Despite facing extreme levels of competition, European airlines look certain to follow Air New Zealand's move to lift prices as the cost of fuel soars.

With profits now at risk, the difference between winners and losers could boil down to hedges on fuel and more efficient planes.

Analysts say crude oil prices, which last week hit fresh highs of more than $US75 a barrel, will squeeze airlines, whose biggest cost after wages comes from filling their tanks.

Germany's Lufthansa is Europe's most hedged major airline. The largest budget carrier, Ryanair, is fully exposed with no fuel hedges.

Most European airlines have locked in cheaper prices for at least some of their fuel by buying hedging contracts. Some have passed on costs to passengers through fuel surcharges.

BA raised its surcharges on long flights last week, a move others could follow.

"We regard it as very likely that flag carriers like Lufthansa or Air France will follow," said WestLB Equity Markets analyst Frank Skodzik.

Analysts say the glimmer of good news in the dim fuel outlook is that underlying travel demand continues to grow, allowing Europe's airlines flexibility to raise fares or surcharges.

Passengers on long flights on some of Europe's biggest airlines now face surcharges of more than €50 ($100).

Profit guidance issued with a fuel assumption based on crude oil at $US60 a barrel is out the window as prices top $US70, setting the stage for a wave of revised forecasts.

Hedging, surcharges and how fuel-efficient their planes are will determine how badly airlines are hit.

"In the current high oil price environment, the question of replacing older, less efficient fleet with newer, lighter aircraft and fuel-efficient engines has gained greater urgency," said Exane BNP Paribas analyst Nick van den Brul. Air France-KLM and BA both report annual results next month, and analysts expect fuel woes will make for cautious outlooks.

Van den Brul believes Air France-KLM has a better mix of fuel hedging and new planes than rival BA.

"The fleet benefits to Air France-KLM are being taken mainly on its B777 range," he said, noting the Boeing 777 burns around 20 per cent less fuel for every passenger an hour than the 747 jumbo jet.

BA said last week that the recent rise in crude prices would slap another £200 million ($562.3 million) on to this year's fuel bill, which is set to jump by £600 million to £2.2 billion.

Like Air France-KLM, top European budget carrier Ryanair is benefiting from a new fleet, with its fuel-efficient Boeing 737-800s helping to fatten its operating margin.

Still, Ryanair is under mounting cost pressure as it flies completely without fuel hedges - a rarity among its peers.

Ryanair has also refused to pass on fuel surcharges, though its chief financial officer said last month that the airline would likely push up fares.

Advocates of surcharges call them a transparent way for carriers to pass fuel costs on to passengers. Critics call it window dressing on fare hikes, and question why airlines with varying exposure to spot oil prices should be imposing similar surcharges.

One carrier with significant exposure is Ryanair's rival easyJet, which also has a young fleet but is hedged on just 24 per cent of its fuel needs.

Analysts say Europe's second-largest budget airline might reveal it has put more hedging in place when it reports mid-year earnings on May 3.

EasyJet's thinner margins leave it less room to breathe than Ryanair.

"A crude analysis shows that at a fuel bill of $US700/metric tonne (of jet fuel, versus $US600), we would have to lower our earnings estimates by 62 per cent," he said.

He noted that higher revenues and more cost-cutting could help to offset the fuel impact.

He said a similar estimate for Ryanair would cut the brokerage's estimates for the Irish carrier by 23 per cent.

BA and Air France-KLM shares trade on 2006 forward price-earnings ratios of about 10, lower than Lufthansa at 14.

The budget carriers trade higher, at about 18 for Ryanair and 20 for easyJet, according to Reuters estimates.

- REUTERS