On his last day as president of the Allied Pilots Association, John Darrah shared what he considers the ugly truth about the year-old turnaround plan that has made
a Wall Street darling.
The turnaround has run aground.
"In the first year of our agreement, AMR's financial returns are nearly $1 billion less than what they had forecast in the model used in concessions talks," Darrah wrote in a 14-page goodbye letter to his fellow pilots on June 30. "For the remainder of this year, that loss is expected to increase to a total of nearly $1.8 billion."
That American's turnaround has gone off track, despite $2 billion in annual wage concessions, is not surprising. In the last year, the airline industry has dealt with the war in Iraq, a major spike in the price of oil, an international outbreak of SARS, a sluggish return of business travel and fare wars with low-cost carriers. But even without these issues, Darrah said American's revival would have still fallen short of internal projections, putting the carrier's long-term viability into question.
"Our concessions strategy gave management enough to avoid bankruptcy last April and buy a few years' time," Darrah said. "What our concessions didn't do is guarantee our long-term survival. That challenge is up to management."
In response, Tim Wagner, a spokesman for American, said the carrier was up to the challenge. He called last spring's financial targets "aggressive" and stressed that the company's turnaround plan, which has cut $4 billion in costs annually, was performing well.
"Other than some unforeseen barriers, like rising oil prices, we feel like the turnaround plan is making tremendous strides," said Wagner. "We're continuing our cost cutting on the operation side and increasing efficiencies. We're comfortable with our progress. Obviously, $600 million to $700 million in extra fuel costs hurts."
The intense debate over the future of American has investors skittish about the industry again. Shares of American fell 61 cents, or 5.4%, to $10.74 on Thursday, after news of Darrah's letter emerged Wednesday night. Other airlines followed suit, with the Amex Airline Index dropping 3.2%, led by
, off 47 cents, or 4.6%, to $9.80; and
, off 50 cents, or 4.7%, to $10.17.
It's Management's Turn to Save the Company
Despite having some of the lowest costs of the network carriers, American has been unable to offset the onslaught of low-cost competitors in the marketplace. With such a large route system, American faces more low-cost competition than any other network carrier and
have been making aggressive moves into new markets, a trend that will only get stronger once Richard Branson's
group launches a low-cost carrier in the U.S.
In Darrah's view, which is backed by the pilots union he just left behind at American, the issue is no longer about cutting costs, but increasing efficiencies and finding ways to thrive in what is now a commoditized business. In other words, American will have to manage its way out of the crisis.
The carrier is trying. This month, American launched a program at Chicago's O'Hare Airport, notorious for delays and traffic-snarled skies, to increase efficiency. Instead of shuffling flight crews from plane to plane, the airline will keep them together on one plane allowing the airline to prevent delays from rippling through the system.
"Say you're flying from Nashville to Chicago and connecting to go somewhere else," explained Gregg Overman, communications director for the pilots' union. "For whatever reason you're delayed -- maybe there's bad weather somewhere -- but you're assigned to fly another aircraft elsewhere in the airport. Now, you stay with the aircraft. They isolate problems rather than inconveniencing other passengers."
With American reiterating that it will not go back to employees and ask for new concessions -- something that Continental has hinted it may have to do -- expect the company to make more announcements about how its business operates.
"Simplifying the business is now a cornerstone of the turnaround," said Wagner. "We're making sure we don't add complexity, which adds expense. We're in this for long term to be a profitable company."
The simple approach works -- Southwest has been profitable for three decades now. But American may be coming a bit too late to the party, powerless to fix the structural problems facing the entire industry.
By boosting efficiencies, the carrier will be able to fly more often and cut costs, but demand for air travel isn't exactly robust with so many airlines expanding flight schedules. As a result, carriers have been discounting seats to keep planes as full as they were a year ago. Indeed, during the month of June, American filled 79% of its seats, about what it did last year, when the economy wasn't as strong.
Why Buy AMR?
The long-term viability of American, the world's largest airline, has severe implications for the rest of the network carriers, many of which haven't even won wage concessions yet. Because of its turnaround plan, American is Wall Street's favorite airline, with nine of the 11 analysts covering it rating it at a buy despite the fact the company's earnings estimates continue to fall.
So why is Wall Street in love with a company that could have limited long-term potential?
Because profitable low-cost carriers are pricey -- and in the short term, American has a tremendous amount of leverage if anything goes right. And there are a number of positive catalysts that could boost American's earnings, according to Prudential Equity Group analyst Daniel Hemme, who cites the company's improving traffic levels, dedication to cutting costs and expanding market share, despite the low-cost competition.
"We believe that upside potential exists for AMR shares are maintaining our overweight rating," said Hemme, in a research note Wednesday. "In short, we believe that current share prices do not fully reflect our forecasts for fundamental improvements and the potential for positive earnings surprises based on positive operating leverage."
With American set to release the results of its second quarter in two weeks, investors and analysts will get another chance to reassess the carrier's future. The red ink is expected to continue, with analysts predicting the carrier will lose 2 cents a share, en route to a fiscal 2004 loss of $1.07.
But while the red ink is expected to turn to black in 2005, as Darrah stresses, it could always get worse if American's management can't figure out a way to stay profitable.
"Unless we collectively as employees and as management begin to realize that we still have a tremendous amount at risk," Darrah wrote, in the last paragraph of his farewell address, "we may soon find ourselves addressing the same realities as our brethren at both
and United Airlines
a unit of
a situation I can assure you will make our present condition shine by comparison."