March 5, 2012

Frontier Enters 2012 Without A Fuel Hedge

Frontier Airlines has no hedges in place on fuel for this year, but the CEO of parent company Republic Airways says he is confident the low-cost carrier subsidiary has reduced its costs and improved its revenue enough to make a profit even if jet fuel prices average $3.50 per gallon this year. Republic’s current plan for Frontier projects “really good margins” at $3.30, Republic Chairman and CEO Bryan Bedford said March 1 during Republic’s fourth-quarter earnings call.

At $3.50 a gallon, about where the price stood as of March 1, “we have to make some assumption on whether we’ll see any of that coming back in the form of ticket price increases,” he added. “But assuming we see some number, you know half of that will come back in ticket price increases, which we think is reasonable, we’re going to get to a positive margin for the year on Frontier.”

Frontier did hedge on fuel in 2011. In an interview with Aviation Week after the call, Bedford said the U.S. airline did look for “a good entry point” to hedge for 2012, but did not find it. Hedging is expensive and requires a decent amount of liquidity or creditworthiness, but Bedford says that was not a factor.
“We’re simply looking for the right entry point,” he reiterated. Republic reported a $3.5 million gain on hedging for Frontier, or 7 cents per gallon, in the fourth quarter of 2011.

Most major U.S. carriers have hedged 20-40% of their fuel costs for 2012. US Airways is a notable exception, having decided to forego hedging the past several years. Most carriers view hedging as an insurance policy against volatile fuel prices, but there is a risk of losing money on the hedges if crude oil prices decline.

The direction of fuel prices this year, and its impact on profitability at Frontier, could affect Republic’s attempt to sell or spin off its low-cost carrier subsidiary this year. Bedford says he believes, based on the level of interest so far, that Republic will be able to determine by August or September who is really interested and make a decision on whether to sell or spin off Frontier.

Republic managed to reduce Frontier’s annual costs by more than $100 million through moves it made last year on labor deals, vendor contracts, and fleet and route network restructuring. Combined with some yield and load factor improvements, the cost-cutting contributed to Frontier’s ability to record a pre-tax income of $7.8 million in the fourth quarter, excluding special items. That compared to an $11.2 million pre-tax loss in the fourth quarter of 2011.

That fourth-quarter profit, however, came on a jet fuel price of $3.22 per gallon. One way in which it could adjust to higher fuel prices is to remove even more of the smaller aircraft from Frontier service, operated by Republic, than it already has.

Frontier will start its spring and summer schedule in mid-April with 16 Airbus A320s, 39 A319s, three A318s, 17 Embraer 190s and three Embraer EJR-145s. Daniel Shurz, Frontier’s senior VP-commercial, noted during the earnings call that “we continue to review the use of any remaining small aircraft in light of the increase in fuel prices.”

Bedford also believes Frontier still can reduce costs a bit more this year on distribution and maintenance, as it strives to reduce its unit costs on Airbus aircraft to under 6 cents per available seat mile, excluding fuel costs. One project to reduce unit costs—increasing the number of seats on the A320 aircraft from 162 to 168—should be completed by May. Shurz said that will reduce unit costs on the A320s by about 3%.

Aviation Weekly

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