Sunday, April 18, 2004

Delta's Hot Seat

New CEO Gerald Grinstein replaced Leo Mullin and faces unfriendly skies as losses mount, stock sags and no end is in sight

By James Pilcher
The Cincinnati Enquirer

Delta Air Lines is in a jam, a fix unprecedented in its 75-year history.

It lost $383 million last quarter - on top of the more than $2 billion in losses over the previous two years. It is wrangling with its pilots over pay cuts that management says would lead the Atlanta-based carrier back to profitability. Salaries for that group, the lone unionized force at Delta, make up its largest labor cost.

But the airline's problems don't stop with the pilots. Its credit is tapped out. Fares continue to be depressed, thanks to increased competition from low-cost carriers and price pressures from Internet shoppers.

To top things off, two of Delta's top corporate officers have jumped ship in the past month.

It's not exactly the kind of setting a new chief executive officer hopes for heading into his first annual shareholders meeting. But that's exactly what faces Gerald Grinstein when he meets with investors for the first time as CEO Friday in Atlanta.

"Delta is in the worst financial plight it's ever been in," said airline equity analyst Sam Buttrick of UBS Equity Research, one of the longest-tenured airline analysts on Wall Street. "The company has never had as much debt and lost as much money with so little remaining access to capital."

Buttrick isn't alone among industry experts and Wall Street investors in wondering about the future of Delta, which has more than 8,000 employees (including workers at Erlanger-based subsidiary Comair) at its Cincinnati/Northern Kentucky International Airport hub. Many have started wondering if Delta might be faced with declaring bankruptcy, although most say that could be at least a year or two away.

Delta stock has lost nearly 80 percent of its value since just before Sept. 11. The company is loaded with $20.6 billion in debt, or 104 percent of its capitalized value. (A company is considered highly leveraged when that rate is more than 30 percent.)

As a result, Delta effectively can't borrow any more, so it must start eating into its cash reserves - $2.2 billion as of the end of last quarter - to pay the bills.

Grinstein, who has refused all interviews recently, acknowledged the company's dire situation to analysts last week.

"Continued losses of this magnitude are unsustainable," Grinstein said on a conference call Wednesday.

Dick Tapke, who runs Tapke Asset Management in Crestview Hills, isn't entirely buying Grinstein's appeal.

"I think that the company is putting the worst face on things as it can to wring more out of the pilots," he said. "Still, the company is having trouble, there's no doubt about that."

Tapke's company has $378.5 million in assets under its management, including more than 300,000 shares of Delta stock. He says the stake makes up just 2 percent of any client's portfolio, and he places it there for its potential upside.

"But even though it's a small percentage of what we do, I take more grief over the fact that the stock is in there than any other," he said

Delta, the nation's No. 3 carrier, isn't alone among airlines facing financial problems.

United and US Airways have either undergone or are still in bankruptcy, which helped both cut labor costs. American Airlines came to the brink of a threatened bankruptcy last year before it got pilots to make concessions.

Continued weak demand for airplane seats has forced down the stock prices of low-cost rivals such as Southwest.

Grinstein, 71, took over for the retiring Leo Mullin on Jan. 1. Mullin made a series of job cuts that reduced Delta's work force by 16,000 in the wake of the Sept. 11 attacks. Yet Delta has lost more than $2 billion over the last two years.

Mullin will complete his departure this week when he turns over his seat as chairman to Delta board member and former General Motors CEO John F. Smith at Thursday's annual meeting.

In addition to Mullin, former president and chief operating officer Fred Reid left last month to help start a new airline.

And on Thursday, Delta's remaining highest-ranked officer under Grinstein departed. Executive vice president and chief operating officer M. Michele Burns said she was resigning to take a similar job at another Atlanta company.

Fuel costs soar

Beyond the aftershocks of Sept. 11, the entire airline industry is now being buffeted by a surge in jet fuel prices (due to an overall increase in oil prices).

A gallon of jet fuel cost nearly $1 a gallon on the spot market Thursday, which is much higher than normal for this time of year. That surge forced Delta to spend $63 million - or 12.3 percent - more on fuel than it did during the same quarter last year.

"The airline industry is not made to be profitable when oil is $35 a barrel," Buttrick said. "It has trouble enough when oil is at $25 a barrel."

Delta is trying to manage the situation by selling its "hedging" contracts, or agreements for buying fuel at a prearranged price, for $83 million. That leaves the airline only the potentially volatile open market for its fuel.

Burns said Wednesday that in a separate interview that the strategy is based on predictions that jet fuel prices will go down gradually over the coming year but acknowledged that the move is a risk.

"But hedging is a calculated risk as well," she said.

Pressing the case

Company officials and analysts see the pilot situation as the biggest problem.

"Pilot reductions alone won't make Delta profitable, but Delta will not become meaningfully profitable without such pilot reductions," Buttrick said.

Grinstein said in Wednesday's conference call that he has met with more than 1,000 pilots in town hall-style meetings to push his case, although he has yet to make his case to pilots here. The union includes nearly 7,400 pilots, including nearly 800 based in Cincinnati. The company is seeking a 30-plus percent pay cut along with productivity increases.

"Our main competitive disadvantage continues to be our pilot costs," said Grinstein, pointing out that the pilots are due to receive a 4.5 percent raise on May 1. "That continues to be the boulder weighing us down."

The pilots' union has countered with a proposal that calls for a 9 percent wage cut in addition to holding back the impending raises, an offer the union says could help Delta restructure its debt.

Union officials have said that they continue to be open for further negotiations. But they characterize the company's offer as being presented as "take it or leave it," which they say is unacceptable.

"In our analysis, the magnitude of the demand is not justified by the data we have been given," said union spokesman Chris Renkel. "We do acknowledge that our plan addresses the debt, which seems to be the $20 billion elephant no one seems to want to talk about."

Still, "we're just a phone call away." Renkel said.

How long this goes on is up to the pilots, Buttrick said, saying the company could be spending $50 million a month more on pilots than its nearest competitors.

"The sooner the pilots accept the marketplace reality, the smaller the concessions will have to be," he said. "The longer the wait, the deeper they have to be.

"That's just math."

Poison pill possible?

All the swirling problems have led many analysts to begin speculating about Delta's potential for entering bankruptcy. With nearly $2.2 billion in ready cash on hand, Buttrick said the company could survive at least the rest of this year and into next year.

Beyond that, he would say only that "Delta will not be OK after two years," a sentiment echoed by many other analysts in several reports issued this week.

Buttrick and others have openly asked about the potential of spinning off regional subsidiaries Comair and Atlantic Southeast Airlines, which could raise more cash, but Grinstein said the two airlines are "valuable parts of the Delta network."

Grinstein also told analysts he was committed to turning the company around without resorting to bankruptcy.

"I believe we can make Delta a great airline once more, and I believe we can do it without resorting to court-ordered restructuring," he said.

Still, said Buttrick, "it's going to get worse before it gets better."


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