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Expectations too high on American Airlines pilot deal as bankruptcy concerns continue

19-Oct-2011

As last weekend approached, the Allied Pilots Association (APA) issued statements that management was highly motivated to complete a deal before the start of the new week, especially since it reports third quarter earnings today and is desperate for good news. APA marshaled its board for a potential meeting on Saturday prior to its regular Autumn meeting on Monday. Everyone expected a deal to be announced. But the failure to reach an accord prompted another dive in AMR stock value and market capitalisation, after the devastating swing earlier in the month prompted by bankruptcy rumours. Analysts then universally pointed to its liquidity, saying it still had time to turn around.

Now, however, analysts are suggesting that a pilot contract will do little to address American's long-term costs problems. Certainly, the expectations are that without a contract, management may opt for bankruptcy no matter how reticent it is to make that move.

Market consensus is for a third quarter loss between USD117 million and USD136 million, a significant narrowing from the USD286 million in the second quarter and USD426 million in the first quarter. It is expected to post a USD1.06 billion loss for 2011. Its loss comes at a time when United Continental and Delta are expected to post USD700 million in profits each.

Concentrating the minds

Even so, the recent violent stock swings certainly served to concentrate the minds of management negotiators.

Both sides said that “significant progress” had been made, but the big issues - wages, scope, pensions and work rules - remain unresolved. The sides have recessed for the moment as pilot negotiators confer with their board. But pilots were also quick to say that does not mean the two have reached yet another impasse in the five-year struggle for a new contract. They have not, APA pointed out.

It is clear that the concerns surrounding the airline did not only concentrate the minds of management, but of pilot negotiators as well. Everyone wants a resolution to the problem sooner than later, they say.

Still, pilots are saying that it will take significant pay increases to gain ratification and they have already signaled their intractability in refusing to grant waivers to work rules to deal with pilot shortages from retirements.

Labour gap cited

While most analysts have accepted American’s argument that the gap between its labour costs and those of its peers who went through bankruptcy is wide, many suggest that may not be the whole story, citing pensions and flight attendant statements that the gap has already closed for them.

The USD800 million annual labour cost gap (cited by American) will close with the latest round of contract negotiations now underway across the industry, the airline says. But the Association of Professional Flight Attendants, representing 18,000 American FAs, believes the cost disparity has already closed thanks to contract improvements at the other mainline carriers. They cited their economic advisor’s analysis which indicated the flight attendant contracts had gained parity as of mid-2011.

AirlineForecasts Analyst Vaughn Cordle cited analysts when he said Delta labour costs per hour are 14% lower than American’s when adjusted for productivity while US Airways are 34% lower. He also cited a 36% labour cost advantage at Southwest and a 51% at JetBlue, concluding it is impossible for American to compete with those statistics.

Analysts also agree that labour is only part of the problem given the fact American generates less revenue than its smaller and larger counterparts. Avondale Partners Bob McAdoo also criticizes its cornerstone strategy of retreating to highly competitive markets in Chicago, Dallas, Los Angeles and Miami and adding capacity. He suggests it would be far easier to make money by concentrating on route profitability rather than adding such services as New York-Budapest which doesn’t do well for anyone.

Flight attendants are quick to point out overall employee concessions hammered out to avoid bankruptcy in 2003 totaled USD1.8 billion as salaries dropped between 16-23% in addition to furloughing thousands more. In addition to suggesting labour cost parity has already been reached, flight attendants can’t help but discuss 2003 concessions in the context of  executive compensation which is 2009, reached USD5.6 million (USD 670 million in base pay) for CEO Gerard Arpey, alone, according to the union. The contract for flight attendants and ground service workers expired nearly four years ago.

American still performing poorly versus peers

If some labour costs have achieved parity, it puts a new spin on American’s pleas for patience since it brings into question why American is still performing so poorly in comparison with its peers. American said fully one fourth of the gap results from wages, work rules, benefits, with another USD200 million because of pension plans.

A Seeking Alpha analysis pointed out the mountain of debt and pension obligations the carrier must surmount, adding it does not have the cash flow to do so.

Pension obligations alone equal about USD24 per share compared to its peers who foisted such obligations on the the US government’s Pension Benefit Guaranty Corporation when they filed for bankruptcy, according to Seeking Alpha. The 05-Oct-2011 analysis further showed American’s underfunded retiree medical and other benefits status reached more than USD8 billion at the end of 2010.

It also pointed to is net debt load, about USD17 per share as of the end of the first quarter, standing at USD5.6 billion not including operating lease capitalisation.

“In order for AMR’s equity to be worth anything, the firm would need to generate a discounted enterprise free cash flow stream amounting to more that USD41 per share or about USD13.7 billion... compared to mid-term enterprise free cash flow number that's north of about $1.4 billion.”

The Seeking Alpha analysis was compounded shortly thereafter by a Fortune analysis citing American labour costs at about 28% of revenues, at a time when US Airways is at 17%, Delta at 18% and United at 20%.

The unfunded pension obligations for those three airlines, calculated at about US15.9 billion, were transferred to the government. Delta only transferred USD4.7 billion, retaining the balance of the total USD10.6 billion. American has unfunded obligations of USD7.9 billion despite its USD200 million in annual payments. In the second quarter, alone, American lost USD286 million, hardly a recipe for digging itself out.

A Fortune analysis showed that even if re-fleeting were already accomplished, the move would still not yield the profitability needed. It said the expected 10% savings in fuel from a new fleet (USD220 million) would still have yielded a loss. The analysis concludes that American simply does not have the time to realise those changes to its cost structure, even if labour costs do not fall. While the company may have USD5 billion in debt, it noted Delta had USD2.8 billion when it entered bankruptcy in 2005 which gave it the wherewithal to continue operations as it navigated its restructuring.

Airlinefinancials.com Bob Herbst is one saying bankruptcy is inevitable, predicting it within the next two or three quarters, despite the cash on hand. Analysts are also suggesting such a move would help the entire industry since it could clear the way for more consolidation. Of course, US Airways was mentioned as the usual suspect especially since American’s market cap is now so low. But it would take a court-supervised reorganisation to make that happen, said Herbst.


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