Airlines and their stocks were some of the hardest hit by the record oil prices. Now as oil prices are falling rapidly the airlines need to worry about shrinking revenues as fewer people choose to fly in the face of hard economic conditions. Several airlines, AAI, LCC and JBLU are reporting 3rd quarter earnings today and a couple, UAUA, NWA and CAL, have already reported giving us a picture of the just passed quarter. Maybe we can project some of this information into the future and make some crystal ball projections about the next few quarters in the airline business.

My quick scan of the recently released results from Continental Airlines (CAL), Northwest Airlines (NWA) and United Airlines (UAUA) popped up a couple of glaring facts:

• For the 3rd quarter CAL spent an additional $606 million for fuel over the same period in 2007. Revenues however only increased by $336 million. This gives a negative difference of $270 million. Excluding the mumbo-jumbo of special items Continental reported a loss of $236 million.
• NWA increased revenue by about 12% or $400 million and would have reported a $93 million profit except for mark-to-market losses of $410 million on fuel hedges.
• United Airlines did a better job of losing money. They spent $946 million more in the 3rd quarter on fuel and managed to increase revenues by a whopping $44 million. Total reported loss was $779 million including a paper loss of $519 million on fuel hedges.

These airlines either hedged against further higher fuel costs and lost a bunch of money or paid significantly higher fuel costs and lost a bunch of money. Excellent management techniques! So far increased revenues have not offset the higher fuel prices or cost of hedging that occurred during the first 3 quarters of 2008. If any of the airlines that are reporting earnings today or in the near future have avoided the fuel price trap I give their management a gold star and investment consideration.

During this time we have read about the airlines making significant reductions in their services to eliminate non-profitable routes and take fuel inefficient aircraft out of service. These are the factors going forward that I think will affect the ability of airlines to generate profits.

• Will the economic slowdown significantly reduce business travel? Business travelers typically pay significantly more for their airline tickets vs. those of us who visit half a dozen air fare web sites to get the lowest price for our leisure travel.
• Can the airlines sustain the price increases they have enacted during very short era of higher fuel prices and bring more dollars to the bottom line? I have little faith that these companies can avoid their habit of cutting prices to steal business from their competitors.
• Will the new charges for extra (or any) checked baggage, food and beverages help profitability or drive customers to those airlines that do not have these charges? I, personally, am in the latter camp.
• Will any of the airlines outside of Southwest (LUV) figure out how to hedge fuel prices by locking in when costs are low and not the opposite?

I have always considered airline stocks a difficult sector to invest in. They have huge capital costs for aircraft and support equipment. They have a high cost, unionized labor force. And they have a customer base that has learned how to take advantage of every low cost opportunity in their convoluted pricing system. An investor really needs to do his homework to find those management teams that can overcome the hurdles and generate profits. Another tack would be to get ahead of market sentiment that lower fuel prices have to help airlines and the share prices will increase until actual results prove otherwise.