Sunday, October 5, 2008
Monday, August 25, 2008
Wednesday, July 2, 2008
Buffett's Berkshire Has Worst First Half Since 1990
By Josh P. Hamilton
July 2 (Bloomberg) -- It must be a bear market because even billionaire Warren Buffett's Berkshire Hathaway Inc. has slumped almost 20 percent since December.
The decline exceeds the drop of the Standard & Poor's 500 Index and marks the worst first half for the Omaha, Nebraska- based investment and holding company since 1990. Price competition has driven down revenue at Berkshire's insurance units, which account for about half of its income.
Berkshire is ``close to getting more fairly priced,'' said Charles Hamilton, a Nashville, Tennessee-based analyst at FTN Midwest Securities Corp., who has a ``neutral'' rating on Berkshire. ``I wouldn't say it presents a buying opportunity right now.''
After reporting record 2007 earnings of $13.2 billion, the 77-year-old Buffett told shareholders in February that profit margins from insurance will drop.
``That party is over,'' Buffett wrote in his annual letter to shareholders in February. ``It is a certainty that insurance industry profit margins, including ours, will fall significantly in 2008.''
Berkshire also has been hurt by the declines of Wells Fargo & Co., American Express Co. and U.S. Bancorp, three of the company's 10 biggest equity holdings at the end of March. Wells Fargo, Berkshire's second-largest holding, dropped 18 percent in the second quarter, while American Express and U.S. Bancorp slipped 14 percent.
Buffett Bulls
Berkshire declined $250 to $119,850 at 9:58 a.m. in New York Stock Exchange composite trading, and is down more than 19 percent since its all-time closing high of $149,200 on Dec. 10. That exceeds the 15 percent slide of the S&P 500 in the same period. Berkshire spokeswoman Jackie Wilson didn't respond to a request for comment.
The slide hasn't deterred Buffett devotees, who think Berkshire's decline represents a buying opportunity.
``I'd put a new client in Berkshire right now,'' said Frank Betz, a partner at Warren, New Jersey-based Carret Zane Capital Management, which oversees $800 million, including Berkshire shares. ``It's probably the highest-quality collection of individual companies that's ever been assembled. Long slides are not in the Berkshire Hathaway lexicon.''
Berkshire bulls are betting with history on their side: the shares advanced in 17 of the past 20 years. The last annual decline was 3.8 percent in 2002. The company had record earnings last year as Buffett booked a $3.5 billion profit on a $500 million investment in oil producer PetroChina Co., and insurance units made money selling coverage against storms that never came.
`Chaotic Markets'
The decline in financial shares may provide Buffett an opportunity to boost holdings, said Whitney Tilson, a principal at New York-based hedge fund T2 Partners, which counts Berkshire among its investments.
``Where Buffett makes his money is taking advantage of weak, chaotic markets,'' Tilson said. ``The odds that Buffett could do a large transformative deal have gone up substantially.''
Buffett built Berkshire over four decades from a failing maker of men's suit linings into a $185 billion company. He plows revenue into companies whose management he trusts and whose business models he deems superior. The billionaire's Berkshire stake makes him the world's richest person, according to Forbes magazine.
With Berkshire's $35 billion in cash, Buffett can scoop up bargains on beaten-down securities and make acquisitions while near-frozen credit markets curb purchases by leveraged buyout firms, Tilson said.
Bond Insurance
Buffett entered the bond insurance business in December as the largest companies in the industry, MBIA Inc. and Ambac Financial Group Inc., struggled to maintain their credit ratings. CIT Group Inc., the lender that lost 84 percent of its market value in 12 months, said yesterday that a Berkshire subsidiary agreed to pay $300 million for its portfolio of loans backing factory-built homes.
Tilson calculates the so-called intrinsic value of Berkshire's assets and operations at $157,000 a share. The stock reached intrinsic value in 11 of the past 12 years, Tilson said. The discount was about 24 percent at yesterday's close.
This year's gap emerged amid a drop in commercial property rates from their peaks after Hurricane Katrina in 2005. Property and casualty prices in the U.S. fell 14 percent in the first quarter from the same period a year earlier, according to a survey by the Council of Insurance Agents and Brokers.
Housing Slump
Berkshire, which owns National Indemnity, General Re Corp. and Geico Corp., saw first-quarter earnings from underwriting insurance policies fall 70 percent to $181 million. Pretax underwriting profit at Berkshire Hathaway Reinsurance Group, which sells catastrophe coverage, dropped 95 percent.
Also damaging to Berkshire's earnings is the biggest housing slump since the Great Depression, which slowed the company's building-related businesses, including Acme Brick, wallboard maker Johns Manville and Shaw Industries, the world's largest carpet manufacturer.
Buffett says the U.S. is mired in ``stagflation,'' a period of slowing economic growth and accelerating inflation.
``We're right in the middle of it,'' Buffett said in a June 25 interview. ``I think the `flation' part will heat up, and I think the `stag' part will get worse.''
An economic recovery isn't ``going to be tomorrow, it's not going to be next month, and may not even be next year,'' he said.
Tilson and Carret Zane's Betz say they'll wait. Berkshire gained 26-fold since 1988 in NYSE trading -- a return more than three times greater than the S&P 500.
``I sleep well,'' Tilson said. ``It's not going to double overnight, but we think it will in five years, which is a 15 percent compounded annual rate. It's the stock you want to own.''
July 2 (Bloomberg) -- It must be a bear market because even billionaire Warren Buffett's Berkshire Hathaway Inc. has slumped almost 20 percent since December.
The decline exceeds the drop of the Standard & Poor's 500 Index and marks the worst first half for the Omaha, Nebraska- based investment and holding company since 1990. Price competition has driven down revenue at Berkshire's insurance units, which account for about half of its income.
Berkshire is ``close to getting more fairly priced,'' said Charles Hamilton, a Nashville, Tennessee-based analyst at FTN Midwest Securities Corp., who has a ``neutral'' rating on Berkshire. ``I wouldn't say it presents a buying opportunity right now.''
After reporting record 2007 earnings of $13.2 billion, the 77-year-old Buffett told shareholders in February that profit margins from insurance will drop.
``That party is over,'' Buffett wrote in his annual letter to shareholders in February. ``It is a certainty that insurance industry profit margins, including ours, will fall significantly in 2008.''
Berkshire also has been hurt by the declines of Wells Fargo & Co., American Express Co. and U.S. Bancorp, three of the company's 10 biggest equity holdings at the end of March. Wells Fargo, Berkshire's second-largest holding, dropped 18 percent in the second quarter, while American Express and U.S. Bancorp slipped 14 percent.
Buffett Bulls
Berkshire declined $250 to $119,850 at 9:58 a.m. in New York Stock Exchange composite trading, and is down more than 19 percent since its all-time closing high of $149,200 on Dec. 10. That exceeds the 15 percent slide of the S&P 500 in the same period. Berkshire spokeswoman Jackie Wilson didn't respond to a request for comment.
The slide hasn't deterred Buffett devotees, who think Berkshire's decline represents a buying opportunity.
``I'd put a new client in Berkshire right now,'' said Frank Betz, a partner at Warren, New Jersey-based Carret Zane Capital Management, which oversees $800 million, including Berkshire shares. ``It's probably the highest-quality collection of individual companies that's ever been assembled. Long slides are not in the Berkshire Hathaway lexicon.''
Berkshire bulls are betting with history on their side: the shares advanced in 17 of the past 20 years. The last annual decline was 3.8 percent in 2002. The company had record earnings last year as Buffett booked a $3.5 billion profit on a $500 million investment in oil producer PetroChina Co., and insurance units made money selling coverage against storms that never came.
`Chaotic Markets'
The decline in financial shares may provide Buffett an opportunity to boost holdings, said Whitney Tilson, a principal at New York-based hedge fund T2 Partners, which counts Berkshire among its investments.
``Where Buffett makes his money is taking advantage of weak, chaotic markets,'' Tilson said. ``The odds that Buffett could do a large transformative deal have gone up substantially.''
Buffett built Berkshire over four decades from a failing maker of men's suit linings into a $185 billion company. He plows revenue into companies whose management he trusts and whose business models he deems superior. The billionaire's Berkshire stake makes him the world's richest person, according to Forbes magazine.
With Berkshire's $35 billion in cash, Buffett can scoop up bargains on beaten-down securities and make acquisitions while near-frozen credit markets curb purchases by leveraged buyout firms, Tilson said.
Bond Insurance
Buffett entered the bond insurance business in December as the largest companies in the industry, MBIA Inc. and Ambac Financial Group Inc., struggled to maintain their credit ratings. CIT Group Inc., the lender that lost 84 percent of its market value in 12 months, said yesterday that a Berkshire subsidiary agreed to pay $300 million for its portfolio of loans backing factory-built homes.
Tilson calculates the so-called intrinsic value of Berkshire's assets and operations at $157,000 a share. The stock reached intrinsic value in 11 of the past 12 years, Tilson said. The discount was about 24 percent at yesterday's close.
This year's gap emerged amid a drop in commercial property rates from their peaks after Hurricane Katrina in 2005. Property and casualty prices in the U.S. fell 14 percent in the first quarter from the same period a year earlier, according to a survey by the Council of Insurance Agents and Brokers.
Housing Slump
Berkshire, which owns National Indemnity, General Re Corp. and Geico Corp., saw first-quarter earnings from underwriting insurance policies fall 70 percent to $181 million. Pretax underwriting profit at Berkshire Hathaway Reinsurance Group, which sells catastrophe coverage, dropped 95 percent.
Also damaging to Berkshire's earnings is the biggest housing slump since the Great Depression, which slowed the company's building-related businesses, including Acme Brick, wallboard maker Johns Manville and Shaw Industries, the world's largest carpet manufacturer.
Buffett says the U.S. is mired in ``stagflation,'' a period of slowing economic growth and accelerating inflation.
``We're right in the middle of it,'' Buffett said in a June 25 interview. ``I think the `flation' part will heat up, and I think the `stag' part will get worse.''
An economic recovery isn't ``going to be tomorrow, it's not going to be next month, and may not even be next year,'' he said.
Tilson and Carret Zane's Betz say they'll wait. Berkshire gained 26-fold since 1988 in NYSE trading -- a return more than three times greater than the S&P 500.
``I sleep well,'' Tilson said. ``It's not going to double overnight, but we think it will in five years, which is a 15 percent compounded annual rate. It's the stock you want to own.''
Monday, June 30, 2008
New Starbucks Brew Attracts Customers, Flak
Fans of Bold Coffee
Bemoan the Rise
Of Pike Place Roast
By JANET ADAMY
A backlash is brewing against Starbucks Corp. over its Pike Place Roast coffee, which has perked up the company's sales by attracting new business, but has alienated a small yet vocal group of longtime patrons.
In April, the Seattle-based chain made the new, milder brew the main drip coffee at its about 11,000 locations across the country. The idea was to offer a more approachable cup of java with a smoother finish.
[A Starbucks employee offers samples of Pike Place Roast at ceremonies in Seattle marking the coffee's launch. ]
UPI/Landov
A Starbucks employee offers samples of Pike Place Roast at ceremonies in Seattle marking the coffee's launch.
But the new strategy, which played down the company's more-established robust roasts, has touched off a debate about what customers think Starbucks should stand for: bold coffee for connoisseurs or a tamer brew for the masses?
Much of that debate is taking place on the company's customer-feedback Web site, which the chain launched in March. The site is littered with thumbs-down verdicts on the new roast. Some small competitors have posted messages there trying to woo away disenchanted Starbucks drinkers.
A customer with the handle Westend complained in a posting on the site that the flavor of Pike Place Roast is "weak, watery and no substitute for the bold." Another, ArtM, called the coffee "a fundamental, grievous error." Beccajav derided its finish as "reminiscent of a taste from the dentist's office."
But Starbucks executives say the chain's aggressive marketing of Pike Place Roast has been a success. Since its introduction, Starbucks' sales of drip coffee have risen by between 5% and 15%, depending on the part of the country, the company says.
"Our satisfaction metrics are up across the board," says Rob Grady, Starbucks' vice president, global beverage. Most of the sales increase in drip coffee has come from new customers "that historically might have not come into Starbucks," he adds.
Starbucks used to brew three types of coffee each day: one bold, one mild and one decaffeinated. The lineup changed weekly.
Now Starbucks outlets serve Pike Place Roast in regular and decaf versions every day. In the morning, stores also brew one of the chain's six bold flavors, like Gold Coast or Caffe Verona. But most Starbucks no longer brew a bold coffee after noon.
The new coffee has clearly struck a chord with some coffee drinkers. But other Starbucks patrons complain that it's gotten hard to buy the stronger-tasting blends on which Starbucks built its reputation. Two weeks ago, after getting thousands of pleas on its Web site, Starbucks again started brewing bold-flavored coffee in the afternoon at some of its locations.
Since New Coke flopped in the 1980s, food and beverage companies have been cautious about changing the taste or formula of their signature offerings. McDonald's Corp., for instance, has kept quiet about the changes in its cooking oil and Big Mac sauce in recent years, in part to minimize the potential for a backlash.
"The worst thing you can do is turn away your loyal customers," says Ron Paul, president of the food consulting firm Technomic Inc. "It's a very risky strategy."
For Starbucks, however, the controversy has succeeded in creating a buzz around the chain's brewed coffees after years in which it largely neglected them in favor of its fancier and pricier coffee-flavored drinks.
Starbucks' Mr. Grady adds that the chain's customers who want a stronger blend of coffee can always ask the barista behind the counter to brew them a cup specially. But some regulars say strong coffee shouldn't require a special order at a chain that popularized it. And some customers who say they have asked a barista to make them a cup of bold coffee say they have been refused.
Pike Place Roast, named for the first Starbucks, located in Seattle's Pike Place Market, has been widely interpreted as the company's attempt to address complaints that its coffee tastes bitter or burnt. But its executives say that wasn't their goal.
Customers were confused by the frequently changing blends available at the company's outlets and wanted something more consistent, says Anthony Carroll, Starbucks manager of green-coffee quality. Surveys of 1,500 consumers also showed they wanted coffee with a smoother finish, he says.
With Chief Executive Howard Schultz pushing for quick action to reverse the company's sliding same-store sales in the U.S., Starbucks developed Pike Place Roast and put it in the company's stores in six months. That's about a year less than it typically takes the chain to refine and implement major new ideas.
Last fall, Mr. Carroll and his colleagues "locked ourselves" in a tasting room at Starbucks headquarters and went through at least 50 coffee blends to settle on the new flavor, Mr. Carroll says. They adjusted the taste by changing variables like the temperature at which the beans were roasted.
"We know what the Starbucks profile is -- it's very near and dear to all of us -- and we weren't going to waver from that signature Starbucks flavor," Mr. Carroll says. He and his team narrowed the field to a group of blends that Mr. Schultz tasted to help make the final choice. Earlier this year, Starbucks tested the coffee with consumers, mostly in the Seattle area.
The new blend won Starbucks a more favorable review from Consumer Reports than the magazine's 2007 assessment, which declared Starbucks coffee "burnt and bitter."
"If you're a confirmed Starbucks drinker and like the taste you're familiar with, this may not be for you," the magazine wrote in a May posting on its Web site. "But if you're looking for coffee with a mild, medium-roasted flavor, Pike Place Roast might be the one to try."
Jolene Tapie of Rancho Cucamonga, Calif., decided the new coffee wasn't for her. "I just couldn't believe that Starbucks would even serve something that bland, tasteless, watery," she says. Ms. Tapie used to visit Starbucks at least three times a week on her way home from her job in a high-school records office. But when her nearby Starbucks replaced the bold blends she favored with Pike Place Roast in the afternoon, she started going to local coffee shops instead.
"I am shocked and disappointed that you have abandoned your original vision," a poster identified as WestPalm wrote on mystarbucksidea.com, the company's feedback site. "You need to wake up before it's too late." Thousands of votes of support for his stance and others like it helped persuade the company to restore a bold coffee variety to the afternoon lineup at about 900 of its locations.
Mr. Grady says Starbucks anticipated complaints. "Every time we change something ... there will be customers that liked it the way it was," he says.
Bemoan the Rise
Of Pike Place Roast
By JANET ADAMY
A backlash is brewing against Starbucks Corp. over its Pike Place Roast coffee, which has perked up the company's sales by attracting new business, but has alienated a small yet vocal group of longtime patrons.
In April, the Seattle-based chain made the new, milder brew the main drip coffee at its about 11,000 locations across the country. The idea was to offer a more approachable cup of java with a smoother finish.
[A Starbucks employee offers samples of Pike Place Roast at ceremonies in Seattle marking the coffee's launch. ]
UPI/Landov
A Starbucks employee offers samples of Pike Place Roast at ceremonies in Seattle marking the coffee's launch.
But the new strategy, which played down the company's more-established robust roasts, has touched off a debate about what customers think Starbucks should stand for: bold coffee for connoisseurs or a tamer brew for the masses?
Much of that debate is taking place on the company's customer-feedback Web site, which the chain launched in March. The site is littered with thumbs-down verdicts on the new roast. Some small competitors have posted messages there trying to woo away disenchanted Starbucks drinkers.
A customer with the handle Westend complained in a posting on the site that the flavor of Pike Place Roast is "weak, watery and no substitute for the bold." Another, ArtM, called the coffee "a fundamental, grievous error." Beccajav derided its finish as "reminiscent of a taste from the dentist's office."
But Starbucks executives say the chain's aggressive marketing of Pike Place Roast has been a success. Since its introduction, Starbucks' sales of drip coffee have risen by between 5% and 15%, depending on the part of the country, the company says.
"Our satisfaction metrics are up across the board," says Rob Grady, Starbucks' vice president, global beverage. Most of the sales increase in drip coffee has come from new customers "that historically might have not come into Starbucks," he adds.
Starbucks used to brew three types of coffee each day: one bold, one mild and one decaffeinated. The lineup changed weekly.
Now Starbucks outlets serve Pike Place Roast in regular and decaf versions every day. In the morning, stores also brew one of the chain's six bold flavors, like Gold Coast or Caffe Verona. But most Starbucks no longer brew a bold coffee after noon.
The new coffee has clearly struck a chord with some coffee drinkers. But other Starbucks patrons complain that it's gotten hard to buy the stronger-tasting blends on which Starbucks built its reputation. Two weeks ago, after getting thousands of pleas on its Web site, Starbucks again started brewing bold-flavored coffee in the afternoon at some of its locations.
Since New Coke flopped in the 1980s, food and beverage companies have been cautious about changing the taste or formula of their signature offerings. McDonald's Corp., for instance, has kept quiet about the changes in its cooking oil and Big Mac sauce in recent years, in part to minimize the potential for a backlash.
"The worst thing you can do is turn away your loyal customers," says Ron Paul, president of the food consulting firm Technomic Inc. "It's a very risky strategy."
For Starbucks, however, the controversy has succeeded in creating a buzz around the chain's brewed coffees after years in which it largely neglected them in favor of its fancier and pricier coffee-flavored drinks.
Starbucks' Mr. Grady adds that the chain's customers who want a stronger blend of coffee can always ask the barista behind the counter to brew them a cup specially. But some regulars say strong coffee shouldn't require a special order at a chain that popularized it. And some customers who say they have asked a barista to make them a cup of bold coffee say they have been refused.
Pike Place Roast, named for the first Starbucks, located in Seattle's Pike Place Market, has been widely interpreted as the company's attempt to address complaints that its coffee tastes bitter or burnt. But its executives say that wasn't their goal.
Customers were confused by the frequently changing blends available at the company's outlets and wanted something more consistent, says Anthony Carroll, Starbucks manager of green-coffee quality. Surveys of 1,500 consumers also showed they wanted coffee with a smoother finish, he says.
With Chief Executive Howard Schultz pushing for quick action to reverse the company's sliding same-store sales in the U.S., Starbucks developed Pike Place Roast and put it in the company's stores in six months. That's about a year less than it typically takes the chain to refine and implement major new ideas.
Last fall, Mr. Carroll and his colleagues "locked ourselves" in a tasting room at Starbucks headquarters and went through at least 50 coffee blends to settle on the new flavor, Mr. Carroll says. They adjusted the taste by changing variables like the temperature at which the beans were roasted.
"We know what the Starbucks profile is -- it's very near and dear to all of us -- and we weren't going to waver from that signature Starbucks flavor," Mr. Carroll says. He and his team narrowed the field to a group of blends that Mr. Schultz tasted to help make the final choice. Earlier this year, Starbucks tested the coffee with consumers, mostly in the Seattle area.
The new blend won Starbucks a more favorable review from Consumer Reports than the magazine's 2007 assessment, which declared Starbucks coffee "burnt and bitter."
"If you're a confirmed Starbucks drinker and like the taste you're familiar with, this may not be for you," the magazine wrote in a May posting on its Web site. "But if you're looking for coffee with a mild, medium-roasted flavor, Pike Place Roast might be the one to try."
Jolene Tapie of Rancho Cucamonga, Calif., decided the new coffee wasn't for her. "I just couldn't believe that Starbucks would even serve something that bland, tasteless, watery," she says. Ms. Tapie used to visit Starbucks at least three times a week on her way home from her job in a high-school records office. But when her nearby Starbucks replaced the bold blends she favored with Pike Place Roast in the afternoon, she started going to local coffee shops instead.
"I am shocked and disappointed that you have abandoned your original vision," a poster identified as WestPalm wrote on mystarbucksidea.com, the company's feedback site. "You need to wake up before it's too late." Thousands of votes of support for his stance and others like it helped persuade the company to restore a bold coffee variety to the afternoon lineup at about 900 of its locations.
Mr. Grady says Starbucks anticipated complaints. "Every time we change something ... there will be customers that liked it the way it was," he says.
Airlines hedge against soaring fuel costs
Since 1999, the program has saved Southwest Airlines $3.5 billion
DALLAS - The computer screen on Scott Topping’s desk at Southwest Airlines flickered with row after row of dates and numbers, but they had nothing to do with arrivals and departures.
They tracked the price of oil futures for the next several months, and they told a grim tale: No letup in sight from record prices for jet fuel.
“We’re on a one-way street right now,” Topping said as he hunched over the screen, shaking his head.
Story continues below ↓advertisement
It’s Topping’s job to oversee Southwest’s battle to control surging fuel costs. It is the most successful program of its kind in the airline industry.
In the first quarter of this year, Southwest paid $1.98 per gallon for fuel. American Airlines paid $2.73, and United paid $2.83 per gallon in the same period.
Since 1999, hedging has saved Southwest $3.5 billion. It has sometimes meant the difference between profit and loss. In the first quarter, hedging gains of $291 million dwarfed Southwest’s $34 million profit.
What is hedging?
Hedging is a financial strategy that lets airlines or other investors protect themselves against rising prices for commodities such as oil by locking in a price for fuel. It has been described as everything from gambling to buying insurance.
Airlines can hedge in several ways, making financial transactions with banks, energy companies or other trading partners.
They can buy contracts for crude oil or unleaded gasoline, and reap a gain if prices rise, offsetting the higher cost of jet fuel.
They can buy a “call option” that gives them the right to buy fuel at a certain price.
They can also use collar hedges, a combination of rights to buy and sell at set prices (“call” and “put” options). Collars provide protection from a decline in prices but less upside if prices rise.
Airlines also use swaps, contracts that require them to buy oil or fuel on a certain date at a set price. These are risky — one party in a swap wins, the other loses.
A risky business
Most airlines use a combination of strategies to reduce risk.
The transactions carry a price tag. Southwest spent $52 million on hedging premiums last year and $14 million in the first three months of this year.
As a result mostly of trades made years ago, Southwest has hedged 70 percent of this year’s fuel needs at $51 per barrel instead of the current price of more than $140 per barrel.
But hedging premiums rise and fall with the price of the underlying commodity, making new trades very expensive. Southwest has not done much trading in the last several months.
Airline executives say hedging is not a bet on the direction of oil prices.
“We view our program as insurance,” said Paul Jacobson, the treasurer of Delta Air Lines Inc. “Our goal is to minimize the volatility of fuel expenses. To do that, you’ve got to be in the market actively without an opinion as to what energy prices will do.”
But hedging carries risks. Airlines can lose money if oil prices turn down and their options expire.
In 2006, Delta won approval from a bankruptcy court and creditors to get into hedging. But the airline got squeezed when oil prices dropped in midyear, and it reported a loss of $108 million from the trading.
Continental Airlines Inc. reported a loss of $18 million from hedging in the first quarter of 2007. But like Delta, Continental is still hedging.
Southwest's success
At one time in the 1990s, most major U.S. airlines hedged some of their fuel costs — even hiring experts from the oil industry to show them the ropes — said Peter Fusaro, chairman of Global Change Associates, an adviser to hedge funds.
That changed after the recession and terror attacks of 2001, which plunged airlines into huge losses. Banks and energy companies that make hedging trades with airlines grew nervous.
“The problem was that most carriers had terrible creditworthiness and couldn’t hedge,” Fusaro said. “Counter-parties feared the carriers would renege on their trades.”
Southwest was the only large U.S. carrier to remain profitable through the downturn. It benefited from higher labor productivity and lower ticket-sales costs. That, and a healthy balance sheet, allowed it to keep hedging when oil was a bargain, compared to today’s prices.
Now, Southwest is the only big carrier that has most of its fuel expenses hedged at below-market prices. And analysts say it will be the only one to earn a profit this year.
While other carriers plan to slash flights later this year — some contracting by more than 10 percent — Southwest expects to grow, although more slowly than it would like.
And Southwest has avoided the kind of fees that annoy passengers. It doesn’t charge for checking luggage or buying a ticket over the phone, doesn’t add a fuel surcharge to the fare, and still gives out free sodas and snacks.
Fuel crisis looming
But how long will the joy ride last?
The bulk of Southwest’s hedges expire gradually by 2012. Replacing them would be very expensive and risky. One plan under study is to go back to hedging only against catastrophically higher oil prices — say, $200 per barrel.
Unless oil prices stabilize or even decline, the airline could face a crisis covering higher fuel costs in just a few years.
“It’s starting to have an impact on their operating plan,” said Betsy Snyder, an analyst for the debt-rating service Standard & Poor’s. “They’re cutting back growth plans for the first time ever and exiting some unprofitable routes.”
Chairman and Chief Executive Gary Kelly said the fuel hedges have bought his airline time to adjust to higher energy costs. Now he wants to find $1.5 billion in new revenue to make up for shrinking fuel hedges.
Among possible sources of the money are higher fares, international service, in-flight entertainment for a charge, and selling hotel rooms on its Web site.
Snyder thinks Southwest can pull it off by following its current strategy of expansion in places like Denver, Philadelphia and Baltimore, where rivals are cutting flights.
“This is a company,” Snyder said, “that has always taken advantage of others’ misfortune.”
DALLAS - The computer screen on Scott Topping’s desk at Southwest Airlines flickered with row after row of dates and numbers, but they had nothing to do with arrivals and departures.
They tracked the price of oil futures for the next several months, and they told a grim tale: No letup in sight from record prices for jet fuel.
“We’re on a one-way street right now,” Topping said as he hunched over the screen, shaking his head.
Story continues below ↓advertisement
It’s Topping’s job to oversee Southwest’s battle to control surging fuel costs. It is the most successful program of its kind in the airline industry.
In the first quarter of this year, Southwest paid $1.98 per gallon for fuel. American Airlines paid $2.73, and United paid $2.83 per gallon in the same period.
Since 1999, hedging has saved Southwest $3.5 billion. It has sometimes meant the difference between profit and loss. In the first quarter, hedging gains of $291 million dwarfed Southwest’s $34 million profit.
What is hedging?
Hedging is a financial strategy that lets airlines or other investors protect themselves against rising prices for commodities such as oil by locking in a price for fuel. It has been described as everything from gambling to buying insurance.
Airlines can hedge in several ways, making financial transactions with banks, energy companies or other trading partners.
They can buy contracts for crude oil or unleaded gasoline, and reap a gain if prices rise, offsetting the higher cost of jet fuel.
They can buy a “call option” that gives them the right to buy fuel at a certain price.
They can also use collar hedges, a combination of rights to buy and sell at set prices (“call” and “put” options). Collars provide protection from a decline in prices but less upside if prices rise.
Airlines also use swaps, contracts that require them to buy oil or fuel on a certain date at a set price. These are risky — one party in a swap wins, the other loses.
A risky business
Most airlines use a combination of strategies to reduce risk.
The transactions carry a price tag. Southwest spent $52 million on hedging premiums last year and $14 million in the first three months of this year.
As a result mostly of trades made years ago, Southwest has hedged 70 percent of this year’s fuel needs at $51 per barrel instead of the current price of more than $140 per barrel.
But hedging premiums rise and fall with the price of the underlying commodity, making new trades very expensive. Southwest has not done much trading in the last several months.
Airline executives say hedging is not a bet on the direction of oil prices.
“We view our program as insurance,” said Paul Jacobson, the treasurer of Delta Air Lines Inc. “Our goal is to minimize the volatility of fuel expenses. To do that, you’ve got to be in the market actively without an opinion as to what energy prices will do.”
But hedging carries risks. Airlines can lose money if oil prices turn down and their options expire.
In 2006, Delta won approval from a bankruptcy court and creditors to get into hedging. But the airline got squeezed when oil prices dropped in midyear, and it reported a loss of $108 million from the trading.
Continental Airlines Inc. reported a loss of $18 million from hedging in the first quarter of 2007. But like Delta, Continental is still hedging.
Southwest's success
At one time in the 1990s, most major U.S. airlines hedged some of their fuel costs — even hiring experts from the oil industry to show them the ropes — said Peter Fusaro, chairman of Global Change Associates, an adviser to hedge funds.
That changed after the recession and terror attacks of 2001, which plunged airlines into huge losses. Banks and energy companies that make hedging trades with airlines grew nervous.
“The problem was that most carriers had terrible creditworthiness and couldn’t hedge,” Fusaro said. “Counter-parties feared the carriers would renege on their trades.”
Southwest was the only large U.S. carrier to remain profitable through the downturn. It benefited from higher labor productivity and lower ticket-sales costs. That, and a healthy balance sheet, allowed it to keep hedging when oil was a bargain, compared to today’s prices.
Now, Southwest is the only big carrier that has most of its fuel expenses hedged at below-market prices. And analysts say it will be the only one to earn a profit this year.
While other carriers plan to slash flights later this year — some contracting by more than 10 percent — Southwest expects to grow, although more slowly than it would like.
And Southwest has avoided the kind of fees that annoy passengers. It doesn’t charge for checking luggage or buying a ticket over the phone, doesn’t add a fuel surcharge to the fare, and still gives out free sodas and snacks.
Fuel crisis looming
But how long will the joy ride last?
The bulk of Southwest’s hedges expire gradually by 2012. Replacing them would be very expensive and risky. One plan under study is to go back to hedging only against catastrophically higher oil prices — say, $200 per barrel.
Unless oil prices stabilize or even decline, the airline could face a crisis covering higher fuel costs in just a few years.
“It’s starting to have an impact on their operating plan,” said Betsy Snyder, an analyst for the debt-rating service Standard & Poor’s. “They’re cutting back growth plans for the first time ever and exiting some unprofitable routes.”
Chairman and Chief Executive Gary Kelly said the fuel hedges have bought his airline time to adjust to higher energy costs. Now he wants to find $1.5 billion in new revenue to make up for shrinking fuel hedges.
Among possible sources of the money are higher fares, international service, in-flight entertainment for a charge, and selling hotel rooms on its Web site.
Snyder thinks Southwest can pull it off by following its current strategy of expansion in places like Denver, Philadelphia and Baltimore, where rivals are cutting flights.
“This is a company,” Snyder said, “that has always taken advantage of others’ misfortune.”
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