AMR May Seek Bankruptcy Protection as Labor Talks Hit Impasse
At the Deutsche Bank Aviation and Transportation Conference held recently, American Airlines (NYSE:AMR) denied seeking bankruptcy liquidation (Chapter 7) but did not rule out the possibility of seeking bankruptcy protection (Chapter 11) to reorganize its labor agreements that put it at a marked disadvantage to airline industry peers such as Delta Airline (NYSE:DAL), Southwest Airlines (NYSE:LUV), US Airways (NYSE:LCC ) and United Continental (NYSE:UAL). In the past, several major players including Delta, US Airways and United Airlines have filed for bankruptcy as a means to renegotiate and reorganize their operations and costs. American Airlines has been avoiding bankruptcy so far, but this looks increasingly likely as negotiations have broken down between the unions and management.
Below we take a look at what factors may cause American to file for bankruptcy protection and how these may impact the company’s valuation.
We have a $5.65 price estimate for American Airlines, implying a premium of around 60% over the current market price.
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Persistent Labor Issues
American Airlines’ work force is said to rank among the lowest in the industry in terms of productivity and according to management estimates, the airline is at $800 million-a-year disadvantage to competitors on labor costs (See AMR Faces Union Stalemate in Bid for $800 Million Labor Savings). While competitors have negotiated better deals with the unions through bankruptcy, American continues to honor its expensive labor agreements. The airline has been trying to negotiate new agreements with its union for years now, but the contract negotiations have recently stalled. While labor costs accounts for about 31% of all operating costs at American, they stand at around 22-23% for Delta and United Continental.
Upgrade Fleet, Eagle Spin Off
However, the airline is trying to make up for higher labor costs through efforts like fleet replacement aimed at deriving fuel efficiencies and the recent spin-off of its regional carrier, American Eagle, to access more competitive rates from other carriers. We wrote about this in a note titled AMR Spins Off American Eagle in Effort to Grow Regional Business. The airline has also entered into new partnerships with British Airways and Japan Airlines that should boost revenue from international travel.
If American files for bankruptcy and comes out with re-negotiated labor contracts, it should be able to reduce its operating expenses by eliminating the $800 million cost disadvantage relative to peers, at least in part. This indicates a potential upside to the current valuation as AMR has been the biggest under-performer among the U.S. airlines this year, in large part due to heavy compensation and retirement liabilities.