Analysts were expecting a loss between USD117-137 million but American finished the third quarter with a USD162 million net loss as fuel increases overshadowed near-record revenue growth. The USD653 million in additional expenses resulted from a 41% fuel price increase. In addition to fuel, American cited foreign exchange losses, which, together with fuel, increased the net loss by USD50 million.
The company seemed to come to the earnings call loaded for bear, once again comparing its metrics to the past to drive home how far the company has come. What is interesting it that the previous comparisons, in a transparent attempt to boost credibility, dated back to 2003 when Gerard Arpey took the helm as chair and CEO. He has been taking increasing heat from analysts who, during the quarter, blatantly suggested he fall on his sword for the good of the airline.
Even so, American brought nothing new to the game in terms of new strategies to pull it out of its unique loss position in the US market. Instead, it reiterated its cash position as well as plans to increase revenues and reduce debt.
Mr Arpey pointed to the company’s “aggressive actions” to position the company for success such as its fleet renewal plans and its Flight Plan 2020 but said new labour contracts were vital to maximising the benefits of those moves. He also pointed to its “powerful assets” including a strong network, alliance partnerships, fleet renewal plans, its “best in the market orderbook” as well as upgraded products and services. He also emphasised the sweet heart financing deals from Boeing and Airbus resulting from its mega order, which is doubted could be matched by competitors. So far, analysts remain unimpressed.
“At this point, our immediate top priority is to address the key remaining foundational issue, which is our cost structure so we can change the competitive dynamics and move our company forward on the path to profitability,” he told analysts. “Capitalising on our strengths we can and will become a profitable company again.”
Management did, however, recount its plans for improving profitability including optimising its trans-Atlantic and Pacific joint businesses through joint pricing, scheduling, sales and joint corporate contracts. American reported it is making headway in corporate travel having signed more than 100 joint corporate deals for trans-Atlantic and Pacific business yielding increased revenue from several key customers.
This is based on its restructured network geared toward business travel that attracts corporate business, especially with its frequent New York-London flights with British Airways and targeted product enhancements. Capacity discipline is also part of the strategy including the reduction in the fourth quarter and day-of-week reductions that will mean capacity in 2012 will be flat or down.
Finally, management pointed to the fact that, within five years, it will have the youngest fleet in the US, which will result in fuel and maintenance savings, especially as it retires its fleet of MD80s and B757s.
Average mainline YE fleet age (in years)
No matter how delicately analysts came at the question, it was clear they did not understand why American did not file for bankruptcy and be done with it. JP Morgan Analyst Jamie Baker, a long-time critic of American’s strategy, even asked the executives to explain why that was not a good strategy.
Mr Arpey could only repeat the company’s position but without uttering the words “American will not file for bankruptcy,” despite considerable fishing on the part of the press.
“As we have said by our past actions and statements, it is not our preference or goal to pursue bankruptcy,” he said. “At the same time, we are well aware that the competition used Chapter 11 to reduce labour costs. We know that in order to be successful and to close our cost gap we have to address labour costs and achieve a competitive cost structure to capitalise on all the other things we have put in place. That is our top priority.”
In a letter to employees Mr Arpey signaled a growing sense of urgency that the only thing left is the elephant in the room: labour costs. To analysts he described what the airline is seeking from employees as a “transformational” agreement to move the company into the next generation contract.
“We want transformational in the way we thought of the fleet deal,” he told analysts. “I say transformational and that means unlike the approach taken by most of the industry where we can achieve, through productivity and other creative ways, our goals. What we are talking about is something good for pilots and good for other stakeholders and that is the intersection we are trying to achieve. That includes work rules, a competitive framework for new hires and increasing productivity more in line with the realities of the marketplace.”
Senior Vice President Human Resources Jeff Brundage said the two sides have achieved significant progress on scope, scheduling, benefits and other key areas but there was still work to be done. However, he added they both see a path to agreement. He reported that the Air Line Pilots Association and American Eagle have a achieved a preliminary agreement in advance of the planned divestiture of the regional operation. Final language is currently being hammered out before being presented to members for a vote.
Much of the questioning from analysts and reporters centred on the pilot negotiations but Arpey noted that talks are also underway with the flight attendants as well as those represented by the Transport Workers Union. None of the executives would discuss a timetable for reaching agreement although Arpey kept emphasizing that it was the company’s top priority.
Analysts questioned how fast benefits could be had, given the fact that the benefits from its aircraft order is still some years out. One suggested that, to date, its two-year-old corner stone strategy has not yielded the benefits expected.
President Tom Horton reminded them the company is currently in a fleet replacement program that is yielding benefits now and that any new labour contracts would be designed to gain immediate benefits. He noted the 130 new B737s added to the fleet between 2009 and now before the new fleet deal begins delivery in 2013.
Signaling there have been increasing questions about the reserves required for credit card processing, Ms Goren said that contrary to what has been published about about USD3.5 billion in hold backs, the renewal of those contracts brought that significantly lower and in line with the industry.
More consolidation ahead - but for American?
Mr Arpey agreed more consolidation was ahead for the industry, adding that it could, of course involve American. In response to a question from CAPA concerning future plans to grow once it achieves new labour agreements, its fleet replacement and profitability, he pointed to the flexibility afforded by the re-fleeting, adding that growth depended on the competitive and economic circumstances being different than is now foreseeable for the US market.
That flexibility really kicks in between 2013 and 2015 with the delivery of the current and new-generation Boeing and Airbus narrowbodies. Mr Horton told CAPA that the order meant that it could continue with just fleet replacement but, with 465 options, could significantly grow as well, depending on the environment.
“We have better partners in Asia,” Mr Arpey responded, “in fact the best with Qantas, Cathay Pacific and JAL. We have plans to grow in that part of the world. In addition, we are bigger than they are in Latin America. Part of our headwinds this year is our flying in Asia is concentrated in Japan and we launched the joint business with JAL the month the tsunami hit. We have great partners in Asia and have Malaysia [Airlines] signed up to join oneworld.”
He indicated that while US point of sale to Japan remained down 30%, echoing Hawaiian that Japan-US traffic has almost fully recovered. In addition, American and JAL were working on joint pricing and product strategies.
Chief Commercial Officer Virasb Vahidi said the disparity between the RASM results between American Airlines and British Airways parent company IAG across the Atlantic was owing to different year on year comparisons and the fact BA took a strike in 2010 as well as the fact the joint business was not launched until 4Q2010.
“We are starting to see benefits of the joint business with positive revenue for the first time,” he said, noting the high percentage of new entrants in the market that drove capacity to the UK up 16%. “We’ve taken action to reduce capacity and reduce our exposure to competitive capacity with the capacity reductions at other carriers. We expect comparisons between IAG and American to move more in tandem in the future.”
Mr Vahidi indicated that the cornerstone strategy has made the network stronger, especially in the top 10 markets out of New York that has retained its positive share gap position in the corporate market. That was so despite the consolidation and creation of two of the largest airlines in the world in United-Continental and Delta. He also reported that the reallocation of regional capacity has yielded improvements in regional performance as well.
New York John F Kennedy International Airport top ten domestic routes
(seats, 17-Oct-2011 to 23-Oct-2011)
The slot swap between Delta and US Airways at LaGuardia and Washington National would not change that, he indicated. “In the top 10 markets we have superior network advantage with our partners and a very significant presence which makes us a very compelling value proposition especially for the banking and media entertainment industries. We have 16 daily departures between New York and London and our schedule and product between New York and San Francisco is unparalleled. We are investing in what is most important to corporate travelers. We are in a good position in New York.”
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“Many of the critical building blocks for a successful future are now in place,” he wrote in a letter to employees. “But as all of you know, and as investors point out in no uncertain terms, there is a big building block remaining. Achieving a competitive cost structure is the one area where, despite a lot of hard work, we have not completed the job.”
The letter seemed a plea for employees to agree to what he termed “next-generation labour contracts” that would put labour costs on par with competitors and will “enable us to be a successful, profitable business, while creating a more secure future for our employees.”
Citing media reports and its volatile stock price, Mr Arpey pointed out there is widespread doubt the company can succeed in its negotiations with the Allied Pilots Association, the Association of Professional Flight Attendants and the Transport Workers Union. He took aim at the work rules calling for reform to improve productivity and establishing a new, competitive framework for new hires. He also called for eliminating restrictions on the way union rules restrict American from conducting business. Finally, he pointed to bringing other elements of the contracts more in line with the realities of the marketplace.
However, the doubt he cited amongst analysts and investors goes beyond the labour contracts and includes doubts about the success of its fleet renewal and the shadow of the several billions in pension shortfall the company has incurred.
Ms Goren said advanced bookings were in line with last year with domestic books up half a point and international off over one point compared to 3Q2010. She attributed that to lower bookings in the Pacific as the result of the Japan disasters. However, she indicated the company was optimistic on the revenue environment heading into the winter.
Fourth quarter fuel is expected to be USD3.02 per gallon and USD3.01 for the year with consolidated consumption expected to be 667 million gallons.
American has already announced sharp reductions in capacity for the fourth quarter to accommodate the higher-than-normal pilot retirements for which APA would not grant it relief. The union wants a final accord instead.
Fourth quarter capacity is expected to be down 3% year on year. CFO Bella Goran pointed to the continued suspension of New York-Haneda and the cancellation of its Chicago-Budapest services as well as reducing frequency and service on certain days of the week as part of the fourth quarter capacity effort. She also said that changes in days of the week is designed to maximize revenues on the days when services are offered.
It sees strong advance bookings. Full year capacity will be up 0.4% year on year for its mainline operations while consolidated capacity will be up about 1.2% year on year. This compares to its original capacity plans, announced earlier this year calling for mainline and consolidated capacity to climb more than 3% and 4%, respectively.
Next year, capacity is expected to be flat to down, said Ms Goren based on the uncertainties surrounding the economy, rather than rising in the low-single digits as originally planned for 2012.
ASMs vs. 2010
Consolidated cost per available seat mile (CASM) ex fuel and the impact of any new labour agreements is expected to increase between 6.2-6.6% in the fourth quarter owing to a lag in expense reduction related to its recent capacity cuts. Higher rent and revenue-related costs are expected to continue. Full-year CASM ex fuel and labour changes is set at a 2-3% increase year-on-year on both a consolidated and mainline basis.
Mainline CASM will be up between 11.7-12.1% for the fourth quarter and between 9.5-10.5% for the year. Ex fuel, mainline CASM will rise between 6.5-6.8%. Consolidated CASM will rise in the same range as mainline for the quarter but increase between 9.6-10.6% for the year. Fuel costs for the year are expected to increase USD1.9 billion year on year.
The company narrowed its losses from the USD286 million posted in 2Q2011 and USD486 million in Q12011. Even so, it will be the lone US carrier to post a loss and third quarter results represented a USD305 million swing from the USD143 million net profit posted in 3Q2010.
The company indicated that the third quarter RASM performance resulted from a Sabre boycott that has since been stopped thanks to court action.
“I think the fact that we highlighted it and in the manner we did,” said Arpey, “indicates how we feel about the impact. We think we have seen a reversal in that but we are pretty lawyered up to say anything more.”
The carrier reported an operating profit of USD39 million on an 8.1% rise in mainline unit revenue compared to the 2010 quarter. It also posted a 7% increase in yield to 14.21 cents, marking the seventh consecutive quarter of yield increases. Meanwhile, consolidated revenue jumped 9.1%, USD534 million, to USD6.376 billion, USD45 million shy of the quarterly record set in 3Q2008.
3Q11 YOY RASM growth
AMR also posted an 8.7% increase in consolidated revenue per available seat mile (RASM) while mainline RASM rose 8.1% to 12.06 cents. Latin RASM growth led its regions rising a powerful 18.8% to 14.11 cents while South America, alone, rose 25% thanks to several pricing initiatives fielded by the company. Latin yield increased 15.1% to 17.01 cents.
Domestic RASM rose 7.7% to 11.76 on a 1.5% drop in ASMs to 23.5 billion. Meanwhile, international was up 8.5% to 12.49 cents on a 2.2% increase in ASMS to 16.5 billion. Domestic yield rose 6.7% to 13.73 cents while international jumped 7.1% to 14.90 cents.
Atlantic RASM rose 3% to 11.68 on a 0.8% increase in ASMs as yield rose 2.1% to 13.56s. Pacific yield dropped 4.4 points to 12.39 cents on a 21.6% increase in ASMs to 2.5 billion. RASM for the region dropped 7.5% to 9.96 cents.
Other revenue continued to rise, jumping 7.8%, or USD47 million, to USD649 million in the quarter on strong yields and load factors. Its critics point to the inability of AMR to match peers in generating revenue but the company reported the 7.8% increase in other revenue was on top of the 5.3% increase in 2010 and was up 75% since 2002.
Mainline load factor set a record in the quarter, rising 0.9 points to 84.9% surpassing the 3Q2010 quarterly record.
Regional revenues rose 18.9% to USD735 million while regional expenses rose to USD800 million compared to USD676 in 3Q2010. That, however, is misleading since the company’s statistics on American Eagle operations revealed the unit is profitable and in 2010 posted a profit of USD40.9 million and was tracking for profitability in 2011.
See related story American Eagle spun off, AA to keep aircraft, debt, give Eagle
Mainline costs increased 3.9% year-on-year resulting from lower-than-planned 2011 capacity in addition to higher aircraft rent and revenue-related expenses. Capacity was flat in the quarter year on year. Operating expense, ex regionals, rose 14.2% to 13.93 cents.
Fuel led its costs not only on the volatility but the impact of jet fuel demand from Asia that keeps jet fuel costs from falling as rapidly as a barrel of crude. Crack spread ranged from USD35-45 at the end of the third quarter, which American said undermined hedging plans.
Average mainline price per gallon rose 41% during the quarter to USD3.15, up from the USD2.24 paid in the year-ago quarter. Consolidated fuel expenses have risen from 15.8% of total operating expenses to 35.6%, said the company, exceeding wages, salaries and benefits by USD479 million.
It pointed to its Fuel Smart efforts to reduce consumption, saying employees managed new record fuel savings of 134 million gallons or USD403 million at its system average price of USD3.01 for 2011.
American’s liquidity continues to give it room to maneuvre at USD4.8 billion in cash and short-term investments, including a restricted balance of USD474 million. Liquidity is down slightly from the USD5 million in the 3Q2010 quarter when restricted cash was USD447 million. Its liquidity was boosted by the successful placement of USD726 million enhanced equipment trust certificates on aircraft to pay down maturing debt.
In contrast to its peers that have been focusing on paying down debt and deleveraging the balance sheet, American’s debt is increasing. Total debt rose to USD16.9 billion from the USD16.2 in the 2010 third quarter. Net debt reached USD12.6 billion compared to USD11.6 billion at the end of 3Q2010.
2012 debt maturities
Ms Goren noted USD1.8 billion in debt matures in 2012 with another USD1 billion in 2013 but the 2012 maturities would unencumbre USD800 million in aircraft. She noted the schedule of deliveries for next year including 28 737 800s and 2 777-300ERs. The USD1.3-1.4 billion financing required was already in place except for the two 777s. She also noted the Boeing/Airbus fleet deals were designed to reduce aircraft financing requirements for 2011 and 2012.
Outlook: labour holds the key
While analysts will probably remain skeptical and may not have total confidence in Mr Arpey, it is clear the company feels it has a path to success and is confident that it will become profitable.
Still the key is its labour contracts, but that seems only a matter of time. The big question remains on whether or not labour is still asking to be made whole from the USD1.8 billion in concessions made in 2003. Considering both sides report progress and many agree being made whole is impossible, it may be labour is not asking for that.
Even so, the progress made this year is more than at any time in the past and is reflective of the growing concern about the company, although executives indicated progress was being made before the early-October bankruptcy stories. All that is a good sign.
As for bankruptcy, despite the company’s protestations it is not in the plans, its refusal to reject such a move outright seems meaningful. It is clear that it, too, depends on labour and whether it can help American avoid bankruptcy for the second time.
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