American Airlines Inc. has secured alliances with some of the world’s best airlines. It has restructured its network to focus on major cities. It is replacing its fleet. It avoided bankruptcy when many of its competitors fled to Chapter 11. What it has not done, however, is make money.
In the 10 years ended December 31, 2010, American’s parent company, AMR Corp., lost $11.5 billion. Its last profitable year was 2007. It has lost money in nine of the past 10 quarters, eight of the past 10 years.
For much of the past decade, many of its major rivals also lost money. But when almost every other US airline made money in 2010, AMR still posted a large loss. AMR is projected to lose money in 2011 and 2012, while its major US competitors are projected to make money.
For a publicly traded company, that’s not a good thing. Top company executives say they’re confident they have a plan to turn the company around but that it will take time.
Simply put, AMR believes that beefing up service at five major US cities and partnering with international carriers will pay off in stronger revenues. It also thinks its current cost disadvantage will disappear over time as other carriers sign new contracts with their labor unions.
“I believe with the strategy we have in place, we’ll be fully competitive,” said AMR and American chairman and chief executive Gerard Arpey.
“Near term, obviously, we have challenges. We have a cost disadvantage. Everybody knows why we have it and how it came to be,” said Tom Horton, president of American and AMR.
“And we have very high oil prices right now. I think if oil prices hadn’t done what they’ve done, many might be talking about the recovery of American Airlines rather than the challenges we face.”
But industry analysts have questioned AMR’s strategy and its explanation that its plans will close the gap with other airlines—with the chorus growing louder in recent months.
“Waiting for the other airlines to sign generous labor contracts does not fix AMR,” Avondale Partners analyst Bob McAdoo said in a May 16 report. “Hoping your competitor will take a particular action is not a strategy.”
“In my opinion, the franchise is still strong; it’s still savable,” senior aerospace specialist Ray Neidl of the Maxim Group said. “But pretty quickly they’re going to have to come up with new ideas, either this management or new management, on what to do with the company.”
In the 1980s and 1990s, American was consistently one of the industry’s most profitable carriers. Between 1981 and 2000, AMR made money in 15 of those 20 years, including $5.5 billion during 1994-2000.
But in 2001, things went wrong, and from a profit standpoint, they’ve stayed pretty wrong for much of the time since.
A badly timed purchase of Trans World Airlines Inc. in April 2001 came just as the US economy was beginning to slow, a decline that became much steeper after the September 11, 2001, terrorist attacks.
The aftermath of September 11 left the industry and American reeling as the number of people traveling plummeted. AMR soon laid off 20,000 employees but still posted large losses in 2001 and the years afterward.
AMR spent the first half of the decade skirting bankruptcy court. Top executives concluded by late 2002 that they would have to cut AMR’s annual expenses by $4 billion if it was to stay solvent.
Of that, $1.8 billion had to come from employees, including $1.6 billion from unionized employees. Faced with a potentially worse outcome in Chapter 11 proceedings, unions in April 2003 agreed to draconian cutbacks in pay and benefits and changes to work rules to keep AMR out of federal bankruptcy court.
As deep as those cuts were, other airlines—Delta Air Lines Inc., Northwest Airlines Corp., US Airways Group Inc. and UAL Corp., parent of United Airlines Inc.—cut even deeper.
Between 2002 and 2005, those carriers went into bankruptcy court to stay alive. Each emerged from bankruptcy a few years later with lower pay and benefits for employees, trimmer workforces and often with better terms on airplanes, facilities and debt.
Now, Arpey, Horton and other AMR executives say they are at an $800-million labor cost disadvantage to the rest of the industry, and cite that as a major reason they lag their competitors in profits.
American has not publicly itemized the gap. But the company points to the fact that AMR has kept its defined benefit pension plan, a rarity in the industry these days, and provides health benefits for many of its retirees, a benefit most airlines do not provide.
AMR has estimated that it must contribute more than $500 million to the pension plan in 2011, and that the retiree medical costs run around $300 million a year.
Company officials are trying to narrow the labor cost gap between AMR and competitors by negotiating contracts that hold the line on American’s costs. For example, it would like to put new employees in 401(k) plans instead of a pension plan, and not pay for retiree medical benefits.
But American has had little success in its labor talks. It has been negotiating for nearly five years with pilots, three-and-a-half years with mechanics, baggage handlers and other ground employees, and three years with flight attendants.
While the company tries to minimize any increase in its costs, unhappy employees want to recover at least a little of what they gave up in pay and benefits eight years ago.
A compensation plan that has given AMR stock to top officials and key employees in recent years also has eroded much of the goodwill that followed the near-miss with bankruptcy.
Now, both sides stand firm in their corners: AMR executives say union employees are better off because they kept their pensions and other benefits, and employees condemn the stock awards as evidence that top executives have prospered while rank-and-file employees have not.
On the revenue side, American since late 2009 has staked its future on “Flightplan 2020.”
The plan carries a strategy to strengthen five “cornerstones”—Dallas/Fort Worth and Miami, two markets that American dominates, and New York, Chicago, and Los Angeles, three heavily contested markets—by adding flights there and reducing flights that don’t hit those cities.
Two years ago, only about 85 percent of American’s flights began or ended in those cities. Today, it’s 98 percent.
“We did that because we thought that would best serve that high-value customer segment,” Horton said.
Those also tend to be the US bases for its partners in the Oneworld global alliance: British Airways, Iberia, Cathay Pacific Airways, Qantas Airways, Japan Airlines and others.
Those carriers’ home airports also give American a strong foothold in other major international markets and connecting points, such as London, Madrid, Tokyo, Sydney and Hong Kong.
American is counting on those growing alliances to raise its revenues and ultimately its profits.
“I think it’s important not to lose sight of that,” Horton said. “This is a long-term strategy, and it is focused on making sure we have beachheads in the most important markets around the world, and I think we’re very well positioned in that regard.”
The strategy has had its share of doubters. Analyst Jamie Baker of JPMorgan has twice urged Arpey to do more than is being done to turn around AMR and American.
In April 2010, Baker noted that AMR’s strategy seemed to consist of two items: the assumption that other airlines’ labor costs would catch up with American’s over time, and expectations that American would bring in more than $500 million in revenues and savings from its global alliances.
“Is this really all you got?” he asked Arpey on a quarterly earnings call.
A year later, in April 2011, Baker cajoled Arpey and Horton to do something innovative to turn AMR around. He recalled that American used to be an industry pioneer, credited with creating frequent-flier programs, using regional carriers, value pricing and other game-changing ideas.
“I realize that maybe not all of these ideas were good ideas, but they were still ideas that were provocative and they shook things up,” Baker said. “Is there any assurance you can give us that you might be working on something similarly radical today?”
McAdoo, the Avondale Partners analyst, looked at American’s network of more than 500 nonstop flights and found a significant number that lost money. He said AMR needs to do some serious pruning and modification of its route system.
“More important than its costs are AMR’s capacity decisions, its market selection, and its unwillingness to halt or reduce flying in markets that are losers,” McAdoo wrote.
“American’s problems are clearly fixable, either by this management or by some other,” he added.
Responded Horton about McAdoo’s report: “The conclusions are wrong, and the analysis is flawed.”
As of last week, the consensus among airline analysts was that AMR will lose more than $600 million in 2011 and more than $100 million next year.
By comparison, analysts expect Delta to earn $1.2 billion this year and $1.7 billion in 2012. United Continental Holdings Inc. is projected to earn nearly $1.3 billion and $1.7 billion in those two years.
But fuel prices will go a long way in determining the size of losses or profits. A 10-cent change in jet fuel prices can alter AMR’s income by nearly $300 million. In 2007, its last profitable year, AMR spent $6.7 billion for fuel; in March, it estimated it will spend nearly $8.5 billion in 2011.
Neidl, the Maxim Group analyst, said AMR is the only carrier among the 15 he covers that he expects to lose money in 2011.
The loss “may not be as big as analysts say, but it still stands out like a sore thumb—why are they losing money?” Neidl said.
AMR stock closed lasy Tuesday at $5.84 a share, giving the airline a market value—333 million shares outstanding multiplied by the share price—of $1.9 billion. Consider that the carrier brought in $1.8 billion between 2005 and 2009 by selling about 120 million shares of stock—the current value of all shares is not much more than that.
By comparison, the carrier’s market value exceeded $5 billion 10 years earlier, despite having less than half as many shares outstanding.
With American’s shares worth a fraction of their former highs and its profits elusive for the foreseeable future, would AMR have been better off following the path of its competitors and filing for bankruptcy to cut its costs?
It’s a question that stirs up Horton and Arpey.
“I don’t think bankruptcy is a formula for success,” Horton said. “It has clearly created near-term cost advantage for our competitors. Longer term, I think that will prove to be temporary.”
Asked if he ever regrets not filing for bankruptcy, Arpey said tersely: “Never.”
“Where do things like almost $3 billion in pension contributions, almost $2 billion in your retiree medical benefits, half a billion dollars in stock options, keeping jobs in America—where are those in the success equation?” he asked.
“How we answer these questions and measure success in America today sends an important message to the next generation of business leaders in this country,” Arpey said. “That bankruptcy is just another tool to be used to achieve success is not the message I would want to send.”
