To Grow Profit, British Air Shrinks

British Airways is taking off on a new route by flying in the face of conventional wisdom.

While airlines typically expand their fleets and the number of cities they serve to grab market share from rivals, the British carrier--one of the world’s largest, whose routes span the globe to 80 countries--is taking the unusual step of shrinking itself to pull out of a financial nose dive.

British Airways’ earnings and stock price have fallen sharply during the last two years. Just recently, the airline said pretax profit for its fiscal second quarter that ended Sept. 30 plummeted 83% from a year earlier, and there’s speculation that when its fiscal year ends March 31, British Airways will show its first loss since the British government sold the airline to the public in 1987.

The main culprit: massive price-cutting among British Airways and its competitors on transatlantic and many intra-European routes, where the carriers shipped lots of airplanes from Asia after Far Eastern economies went sour two years ago.

That led to too many planes chasing too few customers, and the airlines slashed fares--and damaged their profit margins--to keep the jets as full as possible.

So British Airways and its chief executive, Robert Ayling, decided to go in the opposite direction--by shrinking the airline’s capacity by 12% over the next three years.

It will do so by eliminating unprofitable routes, replacing many of the biggest planes in its 280-jet fleet with smaller, more cost-efficient ones and then trying to fill the smaller number of seats with mostly business travelers, who typically pay higher fares than leisure travelers.

And that likely will entail a major human cost. British newspapers recently reported that British Airways was looking at slashing 6,000 jobs, or 10% of its entire work force, over the next three years.

British Airways declined to comment on the prospect for outright layoffs. But it pointed to a statement made last week by its personnel director, Mervyn Walker, who said, “We have always had a voluntary approach to [worker] severance and it is an approach we intend to retain.”

Regardless, investors seem to be embracing the plan.

The airline’s American depositary receipts--the U.S. version of its stock that trade on the New York Stock Exchange--have jumped 22% in just the last four weeks, after plunging nearly 50% the prior 14 months.

The stock has rallied even though other airline shares have tumbled because of the recent surge in oil prices, which portends higher jet-fuel costs that will eat into earnings. British Airways’ ADRs added $2.63 Friday, to $61.88 apiece.

But the airline’s shift promises to be a bumpy ride. Airlines seldom risk surrendering market share for fear they might never get it back. British Airways also risks forever alienating many vacation fliers and other economy-minded travelers, and there’s no guarantee it can garner enough business fliers to make its strategic shift work.

Indeed, airlines worldwide are struggling to lure more corporate travelers these days, because the business fliers themselves are buying more economy class tickets to help their own companies keep a lid on costs.

But Ayling--who’s under growing pressure in Britain to turn around the famed carrier--and his staff defend the strategy as a sensible solution for generating higher earnings.

“Having an absolute market share isn’t necessarily a driver toward profitability,” said Dan Brewin, who oversees British Airways’ North American operations. “It’s a matter of how profitable that market share is.”

He also discounted the risk of losing too many economy fliers, noting that the plan calls for replacing many of British Airways’ jumbo Boeing 747 jetliners with Boeing’s new 777 long-range aircraft, which are still very big planes.

“We’ll still be providing a product for the leisure traveler,” Brewin said.

British Airways, which flies to 167 cities, hasn’t yet detailed all the routes it plans to cut back. But the shift won’t affect British Airways’ current schedule of two flights daily from Los Angeles International Airport to London, and its one daily flight from San Diego to London.

Helping boost the stock are some industry analysts such as Christopher Avery of J.P. Morgan Securities in London, who recently put out a “buy” recommendation on the stock. He said that while Ayling’s plan “is proving controversial . . . we believe it will be vindicated.”

One reason: With Asia starting to rebound, growth in the number of airplane seats serving the Atlantic “should slow down materially” next summer, which would “remove the deep [fare] discounting” on those routes even in the market for business-class seats, Avery recently told clients.

Clive Anderson, analyst at Merrill Lynch & Co. in London, also raised his rating recently, saying “this looks like a turning point” for the airline.

But they’re definitely in the minority. In a current list of analysts’ recommendations, only four have “buys” on the stock while 19 are either neutral or even suggest selling the shares, according to the research firm Nelson Information.

Regardless, the airline’s redirection not only goes against industry norms, it’s a sea change for British Airways itself. The airline long prided itself on being one of the world’s most far-reaching carriers in terms of routes, and for having a consistent record of profits.

But Ayling, a former lawyer who took British Airways’ helm in early 1996, had to do something. Despite its recent upturn, British Airways’ stock has badly trailed its peers and now stands about where it traded five years ago.

In contrast, the American Stock Exchange’s index of major U.S. airline stocks--reflecting the record profitability of the U.S. carriers in recent years--has more than tripled in price over that period.

And British Airways’ much vaunted plan to form a far-reaching alliance with AMR Corp.’s American Airlines, which could have funneled more passengers to British Airways’ planes, fell apart over regulators’ concerns.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Airborne?

The stock of British Airways, the world’s fourth-largest airline, has surged recently amid the carrier’s unusual plan to shrink itself to boost its profit. Weekly closes and latest:

Friday:

$61.88

Sources: Bridge, Air Transport World magazine

How British Airways Ranks:

*--*

Operating revenue Company (billions) 1.United Airlines $17.56 2.American Airlines 17.44 3.Delta Air Lines 14.40 4.British Airways 14.36 5.FedEx 13.67 6.Lufthansa 12.68 7.Air France 9.70 8.Japan Air Lines 9.65 9.Northwest Airlines 9.04 10.US Airways 8.69

*--*