Assessing the Ins and Outs of the American/US Airways Merger

CHARLOTTE, N.C. (TheStreet) -- Investors liked what they heard on Tuesday from newly merged American Airlines   (AAL), which said its 2014 unit revenue gains will exceed competitors' because it will find merger synergies, put more seats on existing airplanes and perhaps reclaim lost corporate travelers. The carrier also hinted that it is likely to pay a dividend in the future.

American shares gained nearly 6% on Tuesday, closing up $1.78 at $31.96.

"We still have to prove it but I think we will outperform the industry this year on (revenue per available seat mile)" said President Scott Kirby, on the carrier's first earnings call following its Dec. 9 merger with US Airways.

In the fourth quarter, American posted a RASM gain of 5% gain, compared with 3% at Delta (DAL) and 3.2% at United (UAL). American projected a 2% to 4% gain in the current quarter. "We are already realizing synergies," Kirby said. "I think that is going to accelerate as we go through the year."

Among the factors fueling RASM gains, American will add seats on three aircraft types. Seat count on the MD-80s has already increased to 140 from 135. Boeing 737-800s will go from 150 to 160 or 164 in the second half of 2014. On the 777-200s, the seat count will increase from 247 to between 260 and 289 in 2014 or 2015. An increase in seat count "is very P&L positive," Kirby said. The cost for extra seats is "very low."
 
Additionally, American expects it will be able to staunch the flow of corporate passengers to other airlines, which benefited competitors particularly Delta. "I think we will win share back by virtue of the network we now have," Kirby said. "We will win some of American's natural share back." He noted, however, that assumptions about recovering share are not built into American's guidance.

In another change, American intends to reorganize its flight banks at its hubs, starting with Miami. In general, it will alter schedules and better size aircraft to routes. The change will be most pronounced in smaller markets, such as Texas cities Lubbock or Abilene, where some regional routes will draw 70-seat aircraft to replace 50-seat aircraft. Charlotte could get more flights to Midwest cities that have American service but not US Airways service.

Another positive for shareholders is that CEO Doug Parker acknowledged that the carrier's year-end cash and investment holdings of $10.3 billion are probably too much. "We agree (that) holding more cash than the company needs is not a good use of shareholder capital," Parker told JPMorgan analyst Jamie Baker, who questioned whether cash would be returned to shareholders.

Baker recently wrote a report about his expectation that American will eventually move to pay dividends. "We understand the point and share the view you have that there is no reason to hold more cash than we need," Parker said.


As an industry, "over the last 10 or 11 years we needed to hold a lot of cash because we were so worried about what might happen," he said. "But if we really have a transformed industry, if we really are producing profits that are real and sustainable (then) there's no need to hold cash as insurance policies. Twenty to 25% of revenue is too much in a world that has been transformed, but let us have a little time to make sure."
 
However, Parker also noted that the carrier does not plan to modify the plans to take delivery of aircraft ordered by both American and US Airways. He said new aircraft represent an investment in reducing fuel costs. "We want those airplanes," he said. "They are a good use of capital."

As a global carrier, American's biggest weakness is in serving Asia. The carrier will begin non-stop Dallas-Shanghai and Dallas-Hong Kong flights in June. But Kirby noted that the merger means that American is now the largest carrier at LAX. Los Angeles "is an important gateway over the long term for us to Asia," Kirby said, as well as "a market that benefits more than most from not being the largest carrier to being the largest carrier."

American was profitable at LAX in 2013, Kirby said, challenging the widespread assumption that no U.S. major carrier makes money at LAX. But he noted that the 2013 profit was "not large," although he expects LAX to be profitable in the coming year. Additionally, he said American has "a great partnership with Alaska (ALK)" and is talking to Alaska about "how to make it better on the West Coast." A tighter alliance could potentially thwart Delta's ambitions in Seattle.

One striking detail among the finer points of the American/US Airways merger is that the inner circle of upper management remains tight. Of the eight executives who were identified as being available to speak on the call, 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.

Chief Financial Officer Derek Kerr noted that cost per available seat mile would rise by 3% to 5% in the current quarter, reflecting the impact of long-awaited compensation increases for US Airways employees.

While RASM performance and expectations impressed investors, they did not resemble the 28% RASM increase the former America West management team produced in its first quarter at US Airways in 2005. It was a quarter when lightning struck and put the America West team on the map. They have not looked back.

Kirby said that came at a time when the industry was "coming from a trough in revenue and profitability." Delta and Northwest had just filed for bankruptcy protection and US Airways sharply reduced capacity. "Here we have a much higher plateau of profitability," Kirby said. "We're not going to have a second quarter like we had in that merger, but (we will have) better profit margins."

Written by Ted Reed in Charlotte, N.C.

To contact this writer, click here.

Follow @tedreednc

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