Shares in American Airlines (NYSE:AMR) sunk to their lowest level in eight years this week as the carrier’s long-running labor dispute continued unabated. The stock has lost almost 75% of its value over the past 12 months, with protracted pay negotiations failing to deliver an agreement between management and pilots. In our analysis below, we argue that the inevitable resolution to this row will help rein in operating expenses and allow the company to compete more effectively against carriers such as US Airways (NYSE:LCC) and Delta Air Lines (NYSE:DAL).
Legacy carriers weighed down by staffing bill
Like many other legacy carriers around the world, American Airlines has in recent times struggled to remain competitive due to its above-average labor bill. With rising fuel costs decimating margins, the need to curtail operating costs is now greater than ever. And yet five years of negotiations with the Allied Pilots Association has failed to produce an agreement.
In contrast to American Airlines, several other legacy carriers have made strides in reducing labor costs since 9/11. US Airways and Delta both pushed through restructuring after they filed for Chapter 11 bankruptcy, while foreign airlines such as British Airways have successfully fought off industrial action to curb staffing costs. But with American Airlines’ pilots still demanding a 7% pay raise in each of the next three years, the carrier continues to lag behind.
According to our latest models, operating expenses excluding fuel costs will account for 53% of passenger revenue in 2011. As long as American Airlines can keep a lid on these costs – limiting annual increases to 0.1% through 2018 – then we believe the stock will recover much of the value it has lost in 2011, climbing back up to $6. Furthermore, a single percentage point reduction in this variable over the same period would almost double our estimate to $11.50.
Labor costs destined to fall one way or another
American Airlines says it would prefer to agree new contracts without restructuring through bankruptcy, but it has also set a self-imposed deadline for a deal. While tentative progress with the Transport Workers Union over dispatchers’ pay will raise hopes that Chapter 11 can be avoided, the precise manner in which it trims labor costs is ultimately immaterial.
The world’s other legacy carriers have for several years been adapting to competitive threats from the low-cost sector and new Middle Eastern rivals – both of which enjoy dramatically lower operating costs. One way or another, American Airlines will be forced to follow suit.
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