How American Has Traveled From Bankruptcy To Record Profits

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Last quarter, American Airlines (NASDAQ:AAL) posted a record $1.2 billion in net profit excluding special items, outperforming rivals United (NYSE:UAL) and Delta (NYSE:DAL) who posted $1.1 billion and $1 billion, respectively, in net profit. [1] For the third straight quarter, American has led United and Delta in profits, and the carrier seems on track to complete a record breaking 2014. This performance by American is especially notable considering that it emerged from bankruptcy just eleven months back. How has American traveled from bankruptcy to record breaking profits so fast? Apart from the strong demand for air travel and lower fuel prices that have helped all airlines in 2014, there are a few other factors that have driven American from bankruptcy to profits. These include American’s gains from an expanded flight network, smooth integration of US Airways, and cost cutting undertaken by American during its bankruptcy period.

We currently have a stock price estimate of $44 for American, approximately in line with its current market price.

See our complete analysis of American Airlines here

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Stable Demand, Lower Fuel Prices

Since American emerged from bankruptcy on December 9, 2013, demand for air travel in the U.S. has steadily grown. This has enabled American to expand its flying capacity while maintaining steady occupancy rates – the percentage of seats occupied by revenue paying passengers on flights. Through October this year, American has expanded its flying capacity by about 2% annually while maintaining a nearly stable occupancy rate. [2] This has directly boosted the carrier’s passenger traffic and revenue in 2014. In addition, lower jet fuel prices caused by a drop in global crude oil prices have boosted American’s 2014 profits.

Expanded Flight Network Driving American’s Top Line

In addition to these macroeconomic factors that have boosted the results of all U.S. airlines in 2014, American’s 2014 profits have benefited from the US Airways merger and cost cutting undertaken during its two year bankruptcy period.

The merger with US Airways has expanded American’s flight network considerably, and the combined airline is realizing synergies as the networks of the old American and US Airways were highly complementary. The old American, with hubs at Dallas Fort Worth, New York, Chicago, Miami and Los Angeles, had a large, spread-out domestic network. But the carrier’s network was less focused on flying passengers up and down the east coast, which is one of the most lucrative markets in the U.S. US Airways, with hubs in Philadelphia and Charlotte, along with a significant presence in Washington DC, plugged the gap in the old American’s network. Thus, the combined network of the two carriers is now strongly positioned in the domestic market.

A strong domestic network in turn is catalyzing American’s international growth, as the domestic network feeds in to the international network. American already has the largest network of any U.S. carrier in Latin America, and its trans-Atlantic service to Europe is on par with Delta and United. The carrier’s relatively weaker position in the trans-Pacific market to Asia could also be enhanced in coming years by leveraging oneworld alliance partnerships. All in all, the expanded flight network resulting from the merger with US Airways has positioned the new American for growth in both the domestic and international markets.

This larger network is particularly attractive to corporate customers, who are the bread and butter of network carriers such as American, United and Delta. With a larger network on which they can earn and use miles, corporate customers are now more likely to register with American’s frequent flier program. In addition, American and US Airways’ existing frequent fliers now have added incentive to stick with the new American due to its expanded network.

We figure gains from this expanded flight network have played a key role in lifting American’s revenue and profit in the first three quarters of this year.

Cost Cutting During Bankruptcy Laid The Foundation

The foundation for this growth in American’s revenue and profit was laid during its two year bankruptcy period in which it slashed operating costs. Chapter 11 protection enabled the carrier to renegotiate contracts with pilots, flight attendants, airport staff, engineers, technicians and other employees. It also enabled the company to limit its pension liabilities. American also re-negotiated many of its office and aircraft lease contracts. New contracts signed following these negotiations lowered the carrier’s operating costs. When expressed as a percentage of its passenger revenue, American’s non-fuel costs fell steadily through its two-year bankruptcy period, from November 2011 to December 2013.

Looking ahead, in our view, American will need to smoothly integrate US Airways to sustain its record profits. Management has so far done a good job of integrating US Airways into American Airlines. US Airways has successfully launched a code share with British Airways, Air Berlin and Finnair, integrating it into the trans-Atlantic joint ventures of American Airlines. Operations of both the old American and US Airways have also been combined at 82 airports including Chicago O’Hare. [3] However, significant work still remains in fully integrating US Airways. The airlines still have to achieve a Single Operating Certificate (SOC), a combined frequent flyer program (which has been announced for 2015) and a single booking window. So, integration will need to go on smoothly in coming months for American to sustain its high profits.

The carrier can take a lesson from United, which floundered while integrating its IT system with that of Continental in 2012. At the time, United’s on-time arrival and departure rates severely dropped, forcing many passengers to leave the airline for other airlines. American needs to watch out for such potholes while integrating US Airways; if it is able to complete this integration without any major issues, it will likely be able to sustain its profits as it benefits from lower costs, higher demand and an expanded flight network.

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Notes:
  1. American’s 2014 Q3 earnings form 8-K, October 23 2014, www.aa.com []
  2. American’s October traffic report, November 10 2014, www.aa.com []
  3. American’s presentation at Raymond James 2014 Global Airline/Transportation Conference, November 6 2014, www.aa.com []