Northwest Airlines ( NWAC) continues to post deep losses, but a recent breakthrough in negotiating wage cuts from unionized pilots could stop the bleeding -- and provide significant upside to shares if a deal can be reached in 2004. Northwest's pilots, represented by the Air Line Pilots Association, on Friday offered $200 million in annual concessions over the next two years, which is less than half of what Northwest has said it needs. In exchange for pay cuts, Northwest's pilots want a stake in the company, and while terms haven't been announced, negotiations are moving in the right direction, unlike the situation at Delta Air Lines ( DAL), where an executive exodus has left labor talks at a standstill. "I think $200 million is not enough, but it's a start," said Helane Becker, airline analyst at The Benchmark Company, a New York-based brokerage. "At this point everything is negotiable. And I think the ownership stake is the only way to go if a deal gets done. It's not like they haven't done this before." The pilots' employee stock ownership plan "owns a chunk of the company," she said. Indeed, after a bitter strike in the fall of 1998, when the industry's prospects were much brighter, pilots signed a four-year contract that gave them a 12% raise -- and a sizable stake in the company. But more than five years after management and labor were at each other's throats, both seem to understand they're in the same boat -- and it is a very leaky one. "It is clear that they share our view of the need for labor cost restructuring. We are scheduled to meet around the end of the month to receive their proposal that will reduce our pilot costs," said Northwest's management, on a conference call discussing first-quarter results. "Our pilots have targeted completion of the negotiation by this fall."
While negotiations appear to be going well, many on Wall Street, such as Credit Suisse First Boston, aren't sure Northwest can get wage concessions in 2004, leaving the stock at a disadvantage to legacy carrier peers such as AMR ( AMR), parent of American Airlines, which has received labor cuts. Furthermore, with pilots offering less than half of what Northwest wants -- and demanding an additional stake in the company -- the package offered by pilots would dilute current shareholders.
of $2.20 would increase by 50%," said David Strine, an airline analyst at Bear Stearns, in a note. "Given Northwest's unit revenue outperformance, one can see the tremendous value that could be created for equity holders if labor costs were to be reduced as they have been elsewhere in the industry." Indeed, the potential turnaround at Northwest could match the one seen by AMR, whose shares have increased eightfold since last March after getting wage cuts. If pilots agree to cut pay, other work groups would likely follow suit. The airline's contract with ramp and gate employees is amendable, and contracts with mechanics and flight attendants become amendable in mid-2005. The company has already made progress on non-labor costs. In the first quarter, maintenance costs dropped 16.5% year over year, offsetting a nearly 10% increase in fuel costs. But overall costs remain the critical issue for Northwest. First-quarter costs may have been marginally higher than they were last year, but Northwest is flying less, and unit costs are rising. The carrier's cost per available seat mile, a key metric known as CASM, rose about 2% in the first quarter, coming in at above 10 cents a mile.
"While this is not an apples-to-apples comparison, Northwest's labor CASM was 4.02 cents, roughly 10%, higher than American's and 29% higher than Southwest's in the first quarter," said William Greene, an airline analyst at Morgan Stanley. "Until Northwest successfully negotiates lower labor costs, it is unlikely that the company's financial picture will improve markedly."
"If you're looking at the route system, they don't have to compete in the east-west transcontinental markets or in East Coast north-south markets. The two most hotly contested markets in the first quarter have been those two," said Becker. "Of course, domestic performance is going to outperform -- they don't have level of low-cost competition that other carriers have in their home market." As a result, Northwest has pricing power that other legacy carriers lack -- yields were up 8.1% in the first quarter.