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American Airlines gives a glimpse of industry recovery, updates on JAL

21-Jan-2010
American Airlines CEO, Gerard Arpey
American Airlines CEO, Gerard Arpey

American Airlines narrowed its loss for the fourth quarter of 2009 and spoke of rebounding business travel. But a wide range of issues from JAL to taxes are ahead for American. Both analysts and media were naturally anxious to hear from the horse's mouth on what is going on with JAL and what the loss of JAL would do to oneworld. But the soundbite that resonated loud and clear was the fact that oneworld and American would oppose vigorously anything that would end up giving its competitor the majority of the US-Japanese market.

In addition, American said approval of a Delta/JAL partnership would "make a mockery" of the recent open skies agreement forged by the two countries.

USD100 million revenue loss if JAL defects

The revenue from its oneworld partnership with JAL amounts to about USD100 million, quantifying for the first time what American would lose if JAL defected to the Delta and the SkyTeam alliance.

“That is meaningful,” said CFO Tom Horton. He added, “strategically, Tokyo represents a valuable gateway to Asia, especially Northeast Asia. We have great partners in Southwest Asia with Cathay and Qantas, but this is an important market. If JAL goes in the other direction, we will huddle with our oneworld partners and consider our options. Other carriers expressed interest in joining oneworld and we will evaluate other carriers in the region, those that are or are not represented by alliance. It will end up being clean sheet.”

On reports that JAL could shrink by 30% and what that would mean to oneworld, Chair & CEO Gerard Arpey said it was premature to speculate on what the JAL restructuring would look like. “We have stressed our objective at oneworld is to ensure a strong and vibrant JAL,” he said. “We would not want to see them shrink, but would instead make them our exclusive gateway into Northeast Asia. Their competitive alternative doesn’t necessarily have that same set of incentives given their competing hub at Inchon.”

While it has been told by JAL, the Japanese government and ETIC that a financial stake would not be welcome at this point, American indicated it has offered the deal that is in the best, long-term interests of JAL. The executives pointed to the strength of oneworld in every part of the world but focused remarks on Latin America. “American has a domestic network that is unrivalled in the US,” said Horton. “We are the largest carrier to Latin America and two of oneworld’s most important partners are in Latin American – LAN and Mexicana. Take our Latin American network and compare communities of interest between Japan and Latin America. And stay tuned for more additions in oneworld’s Latin American network.”

Arpey vociferously condemned a Delta/JAL deal, saying it would make a mockery of the deal the US and Japan made last month on open skies. “We would move aggressively to block the anti-competitive outcome of such a deal,” he said. “That would mean 65% of the traffic is being controlled by one partnership. I would be astonished if that would pass any form of competitive scrutiny. Having a duopoly in a market where we have been restricted for 50 years, it would be a joke; it makes a farce and mockery of the whole process. I don’t think it could happen or it could pass anti-trust scrutiny. We have already seen independent groups, such as the Business Travel Coalition voicing their opposition.”

While American has made that point, Arpey noted that JAL’s situation remains very fluid and could change at any time. He said American’s strategy instead is focused on the benefits of its proposed package of investments and benefits of remaining with oneworld. “We continue to have a dialogue with JAL, the banks, ETIC and the Japanese government. You have to remember that approval is granted if the combination is viewed a pro-competitive. Now US-Japan is split between three alliances and a situation in which one alliance has 65% of the market, it is very difficult to argue that is a pro-competitive outcome.”

Arpey also rejected the suggestion that the way the open skies agreement has been written virtually guarantees ATI approval from the two governments, adding that is not their interpretation of the document.

See related report: JAL bankruptcy a tsunami whose waves circle the world; maybe deadly for oneworld

Improving environment

“Business travelers are back,” CFO Tom Horton reported to analysts and media during yesterday’s webcast. In the past two months, corporate passengers have been up. He added, "corporate revenues have approached flat year over year, which is an achievement, since they have recovered 35 points over the low point in May. We realize we have easier comps in November and December. Nevertheless, when we look at the comps to 2007, we see a clear positive trend through the second half of 2009 so we are encouraged".

“Advance bookings are up modestly versus last year,” he continued. “Domestically, they are down two points, but international is up five points. We are seeing the return of international premium albeit at lower yields. Advanced booking data shows encouraging signs on the yield front, although advanced bookings themselves are a little bit soft. We continue to see an inward shift in the booking curve with stronger close in demand. We expect that to continue.”

American also outlined its pricing strategy. “We have demonstrated that we are not the leader in terms of discounting,” he said. “Our view of elasticity, given the record-setting load factors, is the industry can support higher prices. We have been aggressive in turning off the lower inventory buckets and will continue to do that in 2010. Our revenue has been outperforming others in recent quarters and a good chunk of that is due to revenue management we’ve been doing, especially in anticipating a later booking curve.

“The Atlantic is emblematic of the international environment,” he continued. “Unit revenues have continued to improve with the reduction in industry capacity and the improvement in demand, in particular, for the premium cabins. There is also the improvement in the pricing environment and mixing that together is a healthy combination. We are seeing a return of the business traveler in the long-haul markets and that is where the money is.”

Arpey said that it seems corporations are now responding to the negative consequences of cutting travel. “When that does reverse direction, it tends to do so rapidly,” he said. However he said that American and the industry have a long way to go before reaching RASM levels enjoyed in 2008. RASM remains 12-13% below 3Q2008 levels which were spiked by fuel surcharges and rising fares. Even so, we weren’t rolling in profits back then. We’ve got to get pricing and unit revenues back up. Unit revenues are better than they have been but they are still not good.”

American Airlines RASM growth vs revenue growth: 4Q2008 to 4Q2009

American added there had been no impact from passenger diversion resulting from the Christmas Day terror attempt.

Corner-post hub strategy

American is pursuing what it terms a “corner-post strategy,” focusing on Dallas-Fort Worth, Chicago, Miami, New York and Los Angeles. “We will expand at Chicago and that is part of our strategic initiative and that will be RASM positive in the intermediate term,” said Horton. “We are focusing on the most important markets to our corporate customers and ones that are good jumping off points to the international markets. We will stand and fight in those markets.”

Labour costs - waiting for competitor catch-up

American, which is the only legacy not to enter bankruptcy in the post-9/11 period, is facing cost headwinds compared to its competition which have what Arpey called “bankruptcy labour and pay rates.” Most legacies, including American, are facing contract expirations but what the company is not doing is asking employees to match the labour and pay rates of its competitors. Instead it seems to be waiting for the bankruptcy labor and pay rates to rise.

“If you look at the trailing quarters, their operating results can be explained by paying their people less,” he said. “But we are doing a good job on the revenue side. We want employees to understand that we are at a competitive disadvantage but we will not suggest that [those pay rates] is what we need from them to be successful. We believe over time there will be a convergence and that our competition will not be able to sustain those labour rates forever. I think trying to get our employees to match those rates would be counterproductive.”

Aircraft deliveries continuing

The carrier took delivery of 31 B737-800s last year and expects a further 45 this year and another eight in 2011. The executives noted they will be 35% more efficient than the MD-80s they are replacing. In addition, these deliveries will be cash positive for the airline as they have been financed for more than the cost. Financing for deliveries through 2011 is now in place.

“We have aircraft financing of USD2 billion on our deliveries on about USD1.7 billion aircraft cap ex,” said Horton. “We have more financing than cap ex for two reasons. First on certain financial transactions the proceeds are in excess of the price at which we buy the aircraft. Second, we have pre-delivery deposits of about USD100 million which is like a refund through financing. So, the deliveries are cash positive.”

The airline, having reconfigured its Bombardier CRJ 700s to include a first-class section, will also be taking an additional 22 CRJ 700s in mid year, according to Horton.

Taxes fight

Arpey said that the industry will fight suggestions such as that by House Infrastructure and Transportation Committee Chair, James Oberstar, that taxes be levied on ancillary revenues, which for American rose more than 5% to USD2.3 billion last year. He noted that fees and taxes on passengers have risen at an “astronomical rate. “Over the past decade, fees and taxes and airport charges on airlines and passengers have increased so that more than 20% of what we receive goes to various government entities,” he said.

He added, “I think that we as an industry going to aggressively resist any more taxes and fees on it. Regrettably many in government don’t view airline passengers as voters so, with most budgets, you see increases across the board in fees and taxes. The best thing we can do is resist them.”

4Q2009 results in detail

American Airlines’ net loss for 4Q2009 was down 30.7% to USD1.478 billion compared to the USD2.118 billion loss in the 4Q2008 or USD8.16 per share. Excluding special items and the non-cash tax item, the Company lost USD1.4 billion, or USD4.63 per share, for all of 2009, compared to a loss of USD1.2 billion, or USD4.76 per share, in 2008. It also reported a swing of 46.8% in operating loss to USD1,004 million, compared to USD1,889 million in the year-ago period.

For the fourth quarter 2009, American Airline’s parent company – AMR Corporation – reported a net loss of USD344 million, or USD1.03 per share, for the fourth quarter of 2009 compared to a loss of USD347 million, or USD1.24 per share, for the fourth quarter of 2008. Excluding special items and the non-cash tax item, the company lost USD415 million, or USD1.25 per share, in the quarter. It reported that declines in consolidated revenue, cargo revenue and mainline passenger unit revenue have narrowed sequentially in the third and fourth quarters.

American Airlines operating margin v net margin: 4Q2008 to 4Q2009

The results were impacted by a USD177 million in non-cash special items, consisting of write-downs of aircraft and route and slot authorities. The impairment charges included approximately USD96 million to write down certain route and slot authorities mainly in Latin America; USD42 million to write down certain Embraer RJ-135 aircraft to their estimated fair values; and USD20 million associated with the retirement of the Airbus A300 fleet. Also included is the positive impact of a non-cash tax item of approximately USD248 million primarily related to hedging gains within Other Comprehensive Income during 2009.

The fourth quarter 2008 results included a USD23 million charge for aircraft groundings, facility write-offs and severance related to capacity reductions, and a USD103 million non-cash pension settlement charge driven by a large number of early pilot retirements. American is still under heightened watch by the Federal Aviation Administration resulting from three accidents in Dec-2009. Excluding those special items, the company lost USD221 million, or USD0.79 per share, in the fourth quarter of 2008.

USD4.9 billion cash balance

AMR ended the fourth quarter with approximately USD4.9 billion in cash and short-term investments, In the third and fourth quarters of 2009, the company closed approximately USD5 billion in financing transactions to bolster liquidity, finance the delivery of new B737-800 aircraft and refinance existing debt maturities.

AMR's Total Debt, which it defines as the aggregate of its long-term debt, capital lease obligations, the principal amount of airport facility tax-exempt bonds, and the present value of aircraft operating lease obligations, was USD16.1 billion at the end of the fourth quarter of 2009, AMR's Net Debt, which it defines as Total Debt less unrestricted cash and short-term investments, was USD11.7 billion at the end of the fourth quarter, compared to USD12.0 billion in the fourth quarter of 2008.

In Oct-2010, American Airlines was dropped from the Standard & Poor’s credit watch owing to liquidity boosts coupled with an improved outlook for the sector. Even so, the rating service retained its “negative” outlook, citing its “very weak financial profile” and vulnerability to revenue declines and fuel hikes.

Ancillary revenues – confirmed flight changes, purchased upgrades, buy-on-Board food services, and baggage service charges – grew 6.8 percent to USD582 million in the fourth quarter, compared USD545 million to the fourth quarter of 2008. Even with the drop off in demand and traffic throughout the year, for all of 2009 other revenue increased 5.4% to USD2.3 billion compared to 2008.

"In 2009, our company once again proved its resiliency and ability to battle through challenges while continuing to work toward a successful future," said AMR Chairman and CEO Gerard Arpey. "The fuel crisis of 2008 was replaced by the worst recession in decades, which hurt travel demand severely, and tight capital markets. Yet, we took steps to address those challenges by bolstering our liquidity and financial flexibility and remaining disciplined with capacity. At the same time, we strengthened our global network, reinvested in our fleet and products, and made strides to improve our dependability and our customers' experience.”

Operational performance improving

AMR reported fourth quarter consolidated revenues of approximately USD5.1 billion, a decrease of 7.4% year over year, largely driven by reduced capacity and the reduced demand for air travel and cargo resulting from the global economic downturn.

AMR reported that, despite the continued challenging unit revenue performance, it expects its network strength and its focus on premium traffic “will outpace that of most of its legacy network competitors in 2009.”

Mainline capacity, or total available seat miles, in the fourth quarter decreased by 4.9 percent compared to the same period in 2008, as the company continued to exercise capacity discipline given the still-challenging demand environment.

American's mainline load factor was a record 81.1% during the fourth quarter, compared to 78.3% in the fourth quarter of 2008. American's fourth quarter yield, which represents average fares paid, decreased by 7.6% compared to the fourth quarter of 2008. The decrease in yield was largely due to more aggressive pricing industry-wide and reduced traffic in the premium cabins.

American's mainline cost per available seat mile (unit cost) in the fourth quarter was essentially flat year-on-year, in part due to lower fuel prices. Taking into account the impact of fuel hedging, AMR paid USD2.17 per gallon for jet fuel in the fourth quarter versus USD2.60 a gallon in the fourth quarter of 2008, a 16.4% decrease. As a result, the company paid USD287 million less for fuel in the fourth quarter of 2009 than it would have paid at prevailing prices from the prior-year period.

American Airlines CASM growth vs RASM growth: 4Q2008 to 4Q2009*

Excluding fuel, mainline unit costs in the fourth quarter of 2009 increased by 8.3% year over year, driven by reduced capacity, higher pension expenses, higher materials and repairs expenses, and investments in dependability initiatives.

Retains capacity discipline for 2010

The company is expected to keep mainline capacity flat for the year with a small 0.9% increase compared to 2009, replacing flights terminated by H1N1 fears. However, it plans a 3.2% boost in international capacity beyond 2009 levels, including the launch return of Chicago-Beijing service delayed at the outset of the financial crisis last year. Domestic capacity will drop half a percent.

Mainline capacity in the first quarter of 2010 to decrease by 2.8% compared to the first quarter of 2009, with domestic capacity expected to be down 1.7% and international capacity expected to be down 4.5% compared to first quarter 2009 levels. AMR expects consolidated capacity in the first quarter of 2010 to decrease by 2.6% compared to the first quarter of 2009.

Fuel expenses and hedging

While the cost of jet fuel has been increasing recently and remains volatile, based on the 08-Jan-2010 forward curve, AMR is planning for an average system price of USD2.36 per gallon in the first quarter of 2010 and USD2.42 per gallon for all of 2010.

AMR has 30% of its anticipated first quarter 2010 fuel consumption hedged at an average cap of USD2.55 per gallon of jet fuel equivalent (USD97 per barrel crude equivalent), with 27% subject to an average floor of USD1.84 per gallon of jet fuel equivalent (USD67 per barrel crude equivalent). AMR has 24% of its anticipated full-year consumption hedged at an average cap of USD2.48 per gallon of jet fuel equivalent (USD93 per barrel crude equivalent), with 22% subject to an average floor of USD1.80 per gallon of jet fuel equivalent (USD65 per barrel crude equivalent). As of 8-Jan-2010, the average 2010 market forward price of crude oil was more than USD85 per barrel. Consolidated consumption for the first quarter is expected to be 662 million gallons of jet fuel.

Distribution costs are still dogging the carrier rising more than expected booking fees and commissions, accounting for most of the 1.1% increase in consolidating cost per seat mile for the full year. Analysts have zeroed in on this expense each quarter wondering when the industry can reform the European model to more closely mirror the US distribution costs. AMR also cited higher financing costs for increases in cost per ASM on aircraft delivered in 2009 and 2010. That will be balanced, it said, by a 35% increase in fuel efficiency on a seat mile basis compared to the MD-80s. Mainline fuel efficiency for 2010 is expected to be better by over 2% versus last year.


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