22-Apr-2010 4:35 PM

American Airlines widens net loss to half billion

Analysis

AMR Corp posted its third worst first quarter loss in its history, losing more than half a billion dollars, topping the two post-911 years when its lost over a USD1 billion in each of those years. American cited rising fuel costs for the widening of its net loss in the first quarter from the USD375 million lost in 1Q-2009 to USD505 million lost in the 2010 first quarter, a 34.6% increase. As with Delta, it took a USD53 million hit on the Venezuelan currency in Jan-2010; were it not for that, its net loss would have been USD452 million.

The impact of the earthquakes in Chile and Haiti also took a toll, reducing company revenues by USD20-25 million. The carrier reported that the second quarter will be impacted by the volcanic disruptions, estimated to cost the company USD15 million through Tuesday when it had cancelled 350 flights. However, it said that with offsets from lower fuel consumption and operating expenses, the disruption is not now anticipated to have a large effect on 2Q-2010.

"While we made significant progress in improving revenue performance in the first quarter and enhancing our competitive position, we were simply unable to overcome the challenges of the global economic environment coupled with once-again escalating fuel prices," said AMR Chairman and CEO Gerard Arpey. "As we move forward, we remain focused on continuing to bolster our domestic and international networks, managing our costs, and finding ways to generate additional revenue."

That may be so but several analysts expressed a growing impatience with AMR that it is not making more progress on its results compared to its peers. The carrier has not had a profitable quarter since the third quarter of 2008.

American Airlines operating margin vs net margin: 1Q2008 to 1Q2010*

JP Morgan's Jamie Baker was blunt in noting that American has the highest costs, lowest margins and will be the only carrier expected to lose money this year. He also mentioned that its year-to-date equity performance was trailing its peers.

"Given those factors, we would expect a major overhaul," Baker asked, "and it isn't clear to me that your Flight Plan 2020 will get you what you need. I guess what I'm asking is: is this all you got?"

American Chair Gerard Arpey said it is well known that American has unique headwinds given that it is the only airline that did not undergo bankruptcy - putting it at a significant labour cost disadvantage. But he also noted that now that all contracts are open and under negotiation, there will be some convergence on labour costs as the 19 open contracts across the industry are settled. "We have a cost challenge but I don't think it creates a long-term competitive advantage for those bankrupt companies," he said.

CFO Tom Horton added that American has also been significantly disadvantaged on the alliance front. "We have been competing with one hand tied behind our back" in the international market, he said, noting that its competitors all have anti-trust immunity for their alliances across the Atlantic while American has been fighting tooth and nail to gain approval for its British Airways-Iberia link. He added that American expects final Department of Transportation approval in the second quarter, with EU approval by mid-summer.

The executives defended American's record, noting that over the last seven quarters year-on-year RASM performance has outperformed its peers. American's strategy is to go after revenue premium by concentrating on the top business markets. Mainline absolute RASM, they said, continues to be better than all other legacy carriers and that is expected to continue. Its cornerstone strategy focuses on Los Angeles, Dallas, Miami, New York and Chicago, as well as the implementation of its joint ventures with BA and Iberia and, with Japan Airlines once its newly filed anti-trust petition is approved, these are expected to level the playing field significantly.

American Airlines CASM vs RASM: 1Q2008 to 1Q2010*

Horton said that , judging from the performance of other alliances, the Trans-Atlantic deal will be worth hundreds of millions of dollars, improving American's revenue. "I think the things we are doing to improve relative performance will help," he said. "We are replacing a fuel-inefficient fleet with new fuel-efficient aircraft which will have an immediate margin impact on the network. In addition, our cornerstone strategy is expected to be unit revenue positive and we are only implementing those schedule changes this month. We expect all those things to be accretive."

There was still a lingering doubt over American's strategy which suggested that the initiatives were too long term to make a difference in the short term. CFO Horton disagreed, noting that the airline expects its trans-Atlantic ATI by mid-summer and approval for the JAL joint venture in the fall. "We've had 14 years to plan for that and we anticipate moving very quickly on the implementation and joint schedule, co-location, frequent flier cooperation and cooperative selling," he said. "There is a lot of money there and we will be aggressively pursuing that as soon as we can."

Labour negotiations to be challenging

As to labour negotiations, American's unions have been very aggressive with highly public campaigns against management during the negotiating process. The company has seen no impact from that as far as passengers and travel industry booking away. It is back in negotiations with all three of its labour groups at the behest of the National Mediation Board. "We have to balance the competitiveness of the company and the employees' long term job security against everybody's desire to do better in the short term," said Arpey. "We have to protect job security but also have to ensure we don't price ourselves out the market.

"The gap that exists today [between American's labor costs and those of its peers] is between two- to 400 million a year to as much as a USD1 billion a year," he continued. "But that gap is going to close. It won't happen this summer but I do think it will happen as all these contracts are negotiated. It's already happening and you've seen it in the contracts at Delta and Hawaii which brings their rate increases in line with ours. Now, they have more flexibility that brings productivity and that is something that we are addressing."

Some analysts noted that while there would probably be convergence that would only "drag others down to your level" but would not help American's profitability. "Everyone is losing money today," Arpey responded. "You have to remember that. And there is not a big pot of money to be doled out in contract negotiations around the industry."

He also said that the company is looking for scope relief for regional aircraft, responding to a question on whether the small percentage of RJs in its network impacted its profitability. In fact, American counts RJs as 27% of its fleet while United is at 44%, Delta is at 21% and Continental at 40%. USAirways and Alaska count RJs as 12% and 13%, respectively.

"We're constrained on what we can do with RJs by our scope clause," said, noting that the carrier is adding 23 more CRJs this summer in a two-class configuration. "Our competitors relaxed scope as part of their bankruptcy and have moved more aggressively to use their regional partners. We have to have a constructive dialogue with labour through this round and how we think about our regional partners. They draw feed and push traffic to the mainline. By being able to provide service with regionals you actually strengthen the entire company and the mainline."

Consolidation as an option? - "not threatened"

The company is also banking on its cornerstone strategy to carry it through in the face of what has been proposed to be a major industry consolidation with United in talks with Continental. Sources indicate the US Airways-United negotiations have been tabled for the present as United and Continental work on valuation as well as the details of a stock swap deal.

When asked whether the company was threatened by all the merger activity, Arpey reiterated his previous statement made during its oneworld conference. "I think we have a strong network today and we are confident in our corner post strategy because I think our footprint is already in the most important business markets. So, no. we are not threatened by consolidation and we think it would be a good thing. That is not to say we are not focused on strengthening those corner posts. We have to be mindful how our network evolves not just here in US but around the world."

In response to a question about China Eastern moving to SkyTeam, Arpey crowed about having the best partner in China with Cathay Pacific and its subsidiary Dragon Air as part of oneworld. "Interestingly," he said, "we have a codesharing and frequent flier relationship with China Eastern and they have indicated to use they want to continue that with us. So we are well positioned in China between JAL and Cathay Pacific and our bilateral relationship with China Eastern. A lot will play out in the decade to come in mainland China and that will continue to provide opportunities for us."

However, Arpey indicated that, while oneworld is expansive with good coverage worldwide, it is concerned about a couple of regions. "If you line up the oneworld partners you will see the best airline brands in the world, focused on the most important cities," he continued. "As this evolves there will be fewer and fewer unaligned carriers and lots of competition. We are concerned with only a couple of key regions because we think we are covered reasonably well. One white space was India so we are pleased that Kingfisher elected to join and that will be a very important addition to oneworld."

Mr Horton said most executives have been calling for consolidation for a long time. "If you are going to change the return profile of the industry you have to restructure the industry," he Horton. "The industry needs a more rational structure and consolidation has proven that is the way to achieve a more rational return. We feel confident about our network position irrespective of what happens around us. Consolidation can only be good for the industry and us regardless of whether or not we are a participant."

Arpey agreed. "There are too many hubs, too many airplanes and what that does to pricing - particularly one-stop pricing is bad," he said. "So whatever leads us to a rational balance between supply and demand is a good thing." In response to a question about whether a merger between a legacy and low-cost carrier would work, he said "I wouldn't say never to anything in this industry."

An "inflection point" reached

Analysts asked whether, given the rates of return, as well as the fact there is still too much capacity, why the industry just does not shrink another seven percent to gain pricing traction. "I think everyone in the industry is trying to ascertain what the new level of demand really is," said Arpey in response. "We've had an extraordinary downturn and extraordinary losses for airlines. But now we are seeing a pretty significant inflection point in terms of corporate demand and pricing and that is the byproduct of capacity cuts we made in last 18 months. The network carriers are down 12% from the first quarter of 2008. The question is whether that is enough. That remains to be seen. I think it is premature to make another big cut in capacity until we see how the economy begins to settle out. We are seeing increases in unit revenues."

The results - Atlantic the strongest performer

Horton reported that unit revenue was approaching 2008 level and added that the Atlantic had the strongest international unit revenue improvement in the industry.

"There are positive signs business is back on the road," he said. "Our corporate revenue was up 17%, two thirds of which was from traffic and the rest from higher yields. Domestic corporate revenue increased 30% as companies loosened restrictive travel policies in order to stimulate their own businesses. There are fewer fare sales and we've had more success in raising fares. In the first quarter of 2009 we had no successful fare increased. This year two thirds of the industry fare increases at least have been successful. Our advanced bookings are up slightly over last year and while domestic is down three quarters of a point, international is up two points. Yields are trending up since last year and we see more close in advance bookings which were flat at the end of the fourth quarter and is now up two points."

Consolidated revenues rose 4.7% to USD5.1 billion for the quarter with revenues from ancillaries, regional affiliates and cargo rising year on year. Consolidated RASM rose 7.3% in the first quarter.

Comparisons to 2008 (year-on-two) show total operating revenue declining 9.2% and total operating costs declining 10.7%.

American Airlines 1Q2008 total operating revenue vs 1Q2010 total operating costs

The result is a widening in operating loss.

American Airlines 1Q2008 operating loss vs 1Q2010 operating loss

The airline is maintaining its tight capacity control which it cited for the increases. The company's total operating revenue was about USD229 million better in first quarter 2010 compared to the unprecedented first quarter of the previous year. American's mainline load factor was up 2.2 points to 77.9% during quarter.

American's passenger revenues experienced a 4.1% hike to USD3.8 billion, but the carrier posted an operating loss of USD298 million, a 53.7% increase. Other revenues increased 5.8% to USD585 million in the quarter on the strength of baggage and advantage partner revenues. Total operating revenues rose 4.7% to USD5 billion.

Yield increased 3.7% to 13.35 cents while PRASM rose 6.8% to 10.40 cents. Operating expense per available seat mile rose 9.2% to 12.91 cents which did not include regional affiliate expense. American's RPMs were flat at 0.4% to 28.7 billion while ASMs declined 2.5% to 36.8 billion. Load factor rose 2.2 points to 77.9%.

Regional revenues rose 9% to USD498 million during the 1Q-2010. Regional expenses once again overwhelmed revenues rising to USD629 million compared to USD596 million in the year-ago period. Regional affiliates flew 1.8 billion revenue passengers miles, virtually flat at 0.2% while available seat miles declined by 1.6% to 2.7 billion. Passenger load factor rose 1.2 points to 67.2%

Arpey told CAPA's America Airline Daily that while regional costs may overwhelm expenses, the feed from American Eagle to American accounted for 10 points of load factor on American. "We look at it that way in terms of costs," he said, "That down-line contribution of 10 points amounts to billions of dollars of additional revenue. But it is also part of a network that needs to produce an overall profit. It we step back and look at it, all these networks have to general more revenue to cover both the regional and mainline operations. We expect that with the recovery we will be driving revenue beyond our cost structure."

9.3% of revenue from regional feeders

American is the only airline to quantify incremental revenue from its feeders, saying approximately 9.3% of its mainline passenger revenue comes from affiliate feed. For 2009 the amount was USD1.4 billion, somewhat shy of the USD1.7 billion it reported in 2008. That money is in addition to what is reported under affiliate income, which during the first quarter was USD498 million. That means, that regional feed earns it 1.898 billion more than accommodating USD629 million in costs attributed to its feeders.

All regions were down on RASM and ASMs. Domestic RASM dropped slightly 0.9% to 10.24 cents while international RAMS declined 4.9% to 10.65 cents. Yield for domestic rose 5.2% to 13.00 cents while international yield rose only 1.4% to 13.94 cents.

Costs - fuel up USD211 million for the quarter

AMR cited capacity reduction headwinds, maintenance and revenue-related expenses for the 5.7% jump in mainline unit costs in the first quarter increased 5.7 percent year over year, excluding fuel costs. Fuel cost the company an additional USD211 million this quarter compared to the first quarter of 2009 and hike of 32 cents a gallon.

Guidance - cash solid, capacity to remain nearly unchanged, but CASM up 9.7% in 2Q2010

AMR ended the first quarter with approximately USD5.0 billion in cash and short-term investments, including a restricted balance of USD460 million, compared to a balance of USD3.3 billion in cash and short-term investments, including a restricted balance of USD462 million, at the end of the first quarter of 2009.

The company's total debt reached USD 15.9 billion at the end of the first quarter, up from the USD14.4 billion in the 1Q-2009. Net debt was USD11.4 billion at the end of the first quarter, down slightly from USD11.5 billion in the year-ago period.

With the reinstatement of flying cancelled owing to the H1N1 virus, AMR expects its full-year mainline capacity to increase by 1.0% in 2010 compared to 2009, with domestic capacity down 0.2%. International will increase 3.0%, which includes the launch of Chicago-Beijing, was deferred from last year. On a consolidated basis, AMR expects full-year capacity to increase by 1.5%.

AMR expects mainline capacity in the second quarter of 2010 to increase by only 0.7% compared to the second quarter of 2009, with domestic capacity expected to be down 0.3% and international capacity expected to be up 2.4% compared to second quarter 2009 levels. AMR expects consolidated capacity in the second quarter of 2010 to increase by 1.0% compared to the second quarter of 2009.

Mainline CASM ex special items, is expected to rise 9.7% to during the second quarter. Ex fuel it will rise 3.6%. Similarly, for the full year, AMR is expecting mainline costs to rise 5.8% and, ex fuel, 1.5%. Consolidated CASM for the quarter will increase by 9.5% and, ex fuel, by 3.3%. For the full year, CASM will rise 5.9% and, ex fuel, by 1.5% on expected higher revenue-related expenses such as booking fees and commissions, landing fees and facilities costs, and financing costs related to new aircraft deliveries.