Tough Times for Airlines but American Has a Plan

The airline continues the trend of predicting weakening revenue in the second half, but also articulates a plan to deal with the issues.
By Lou Whiteman ,

American Airlines (AAL) - Get Report reported second-quarter results that echoed what has been said by most of its rivals, generating net income and revenue that met or beat expectations but warning of tough times ahead. In American's case, investors cheered the results, perhaps because airline management articulated a plan to deal with the issues.

Fort Worth-based American reported net income of $1.68 a share, matching FacSet consensus and slightly beating the estimate published by Zacks Investment Research, on revenue of $10.36 billion. Passenger revenue per available seat mile, a key industry metric, dropped by 6.3% in the quarter year over year due to a combination of competitive capacity growth, global macroeconomic weakness and the impact of a strong dollar.

The airline is changing the way it guides on revenue, moving away from a focus on flight revenue and toward total revenue as fees and ancillary services grow to be a more important part of the business. The airline said it expects the metric for total revenue to fall by between 3.5% and 5.5% in the third quarter, which according to JPMorgan's analysis would mean passenger revenue would be down 4.5% to 6.5%. Those estimates are similar to what much of the industry is expecting, and would be slightly better than what analysts had previously anticipated in the third quarter.

Shares of American traded up more 3% on Friday morning, a stark contrast to Dallas-area rival Southwest Airlines (LUV) - Get Report  who saw its shares fall by 10% midday Thursday after issuing a similar forecast. The difference for Wall Street is that American laid out a clear plan for what it intends to do about the revenue weakness, while Southwest, in the words of Wolfe Research analyst Hunter Keay, "seemed oddly unprepared for the onslaught of questions around the topic of capacity growth."

American was the first major airline to report weakness in yields on close-in business fares, and the airline this quarter stood alone in saying it isn't currently experiencing intensifying pressure on those more lucrative tickets. President Scott Kirby, on a call with analysts, suggested that the rest of the industry might finally be catching up to what American has been seeing for about a year, as ultra-low-cost carriers that were bombarding American's key markets a year ago have slowed growth in American hubs and are now focusing elsewhere.

Kirby said that corporate demand is strong, but "we have a lot of low fares, so they are getting a deal right now."

Longer-term American, like rivals Delta Air Lines (DAL) - Get Report  and United Continental (UAL) - Get Report , is working to alter its fare structure to better compete with a new crop of discounters including Spirit Airlines and Frontier Airlines. Kirby said there was a need for a "structural change" similar to how the industry evolved away from using Saturday night stay requirements and other rules to segment business fares, a process that is underway but takes time to implement.

In the quarters to come, passengers flying on American and its rivals will need to choose not just between first-class and economy tickets, but also between cheaper bare-bones economy with extras available for a fee and more premium economy service with built-in benefits. Airlines hope that these new fare structures will allow them to both compete on price with discounters, and extract extra revenue from those flying on an expense account.

The airline is also taking steps to slow fleet growth in response to rising industry capacity. American said it has reached an agreement with Airbus to defer delivery of 22 A350 jets it has on order, pushing back delivery of a number of long-range aircraft. Those planes were earmarked as replacements for older aircraft that American can now either extend the lease on or retire, depending on capacity needs.

American would figure to be among the U.S. airlines most exposed to Brexit given its strong ties and partnership with British Airways. The airline predicted weakness in Europe in the months to come due to a range of factors including local economics, Brexit and terrorism headline fears, but Kirby said he believes the near-term impact of the U.K. vote to leave the European Union is manageable.

While the falling U.K. pound is a negative -- Kirby said that the pound has replaced the Brazilian real as the company's biggest forex headwind -- he expects an increase in the amount of transatlantic business traffic as executives and their consultants attempt to navigate the Brexit impact. So far American has not seen a drop off in bookings, and the market is not implying a loss of business confidence that could result in a cutback in corporate travel budgets.

Over the longer term Brexit could impact the company should changes come to the U.K. economy, as well as a risk to existing treaties and international flying rights, but those decisions are still years away.

Kirby said that American has "a great relationship with IAG," British Airways' parent company, and is constantly discussing transatlantic capacity.

Loading ...