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Despite Euphoria, American Airlines Faces Some Harsh Realities

Stocks in this article: AAL DAL UAL

CHARLOTTE, N.C. (TheStreet) -- Now that euphoria has set in around the US Airways/American (AAL) merger, it is probably time to question whether everything is quite so rosy as it looks.

This week, analysts were busily raising estimates after new American reported earnings on Tuesday. As a result, on Wednesday, every other major airline stock fell, but American gained 3%. Shares have gained 34% this year. Meanwhile, United (UAL) is up 23%, Delta (DAL) is up 11%, Southwest (LUV) is up 13% and the S&P 500 Index is down 3%. It is as if American flies in a parallel universe, where all news is good news.

The airline industry came to respect the America West management team because of what it did after taking over at US Airways in 2005. The team, led by CEO Doug Parker, took two weak airlines and made them into one strong airline. It took over three US Airways hubs in Charlotte, Philadelphia and Washington and made them all better. It benefited from closing its hub in Las Vegas and from continuing the Pittsburgh downsizing that previous management began. It also made the airplanes run on time.

But the America West team also benefited immensely from two unusual and concurrent phenomena. One was a peculiar seniority award that divided its pilots, who were trapped into maintaining two of the worst contracts in the airline industry for 10 years. That in turn delayed negotiations with the flight attendants, who didn't get a new contract either -- not until the America West team was ready to move on a merger with American.

Now US Airways' labor costs are expected to rise by $400 million annually, with cost per available seat mile rising 3% to 5% in the current quarter, Chief Financial Officer Derek Kerr said on Tuesday's earnings call.

The second phenomenon is equally unique: At the same time the America West team was doing everything right, most of the rest of the airline industry was also doing everything right. The industry consolidated successfully, developed capacity discipline and invented an auxiliary revenue stream. And the economy has improved steadily for four years.

Give Parker credit for triggering consolidation. Every legacy airline not only embraced capacity discipline, but also claimed to have thought of it first. As for an ancillary revenue strategy, United developed that one.

As the America West team faces its biggest challenge, it remains an insular group. On the American earnings call Tuesday, eight executives were identified as being available to speak. Of those, seven were most recently employed at US Airways, and six previously worked at America West. Just one, Bev Goulet, chief integration officer, came from American.

Success has its rewards, but the jury is out on whether a lack of inclusiveness is the best way to ensure that it continues.

Additionally, this time the problems are different, the competition is more intense and new American does not start with the strongest hand or even the second-strongest hand. Rather, new American has its New York hub in Philadelphia and its West Coast hub in Phoenix. Moreover, winning in the former US Airways hubs -- where US Airways dominated for years -- is not the same as winning in Chicago or Los Angeles or Asia.

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