AMR Launches Industry Reporting with $390M Loss

While AMR kicked off the second quarter industry earnings reports, much of its experience tips off what the rest of the industry will be reporting – losses, the chase for liquidity and unencumbered assets, further capacity cuts and even shorter booking windows in the out quarters.

AMR Chair Gerard Arpey ticked off the industry headwinds that are, by now, excruciatingly familiar – the global economic downturn, still-volatile fuel prices, challenging capital markets, which CFO Tom Horton called the most difficult in memory, and H1N1 – with the flu cited as one of the main reasons the airline's second quarter revenues dropped 16% from last year. “Combined with lower capacity, this resulted in mainline passenger revenues down by over 22% versus last year,” he said, adding such declines haven’t been seen since the third and fourth quarters of 2001 when they were even steeper."

“If someone predicted oil prices would be cut in half from nearly $150 a barrel a year ago, yet the airline industry would be in worse shape, not many people would have believed it -- but that seems to be exactly what has happened,” said Arpey in a letter to employees that seemed to succinctly sum up the state of affairs in the airline industry. “As you know, a year ago we were moving aggressively to confront the problem of skyrocketing fuel costs. At the time I said that the airline industry was not built for $130 a barrel oil. That's still true, but today I must add that neither is the industry built for today's environment of negative global economic growth and erratic capital markets.”

Analyst’s questions yesterday reflected their concerns – cash reserves and debt and what airlines have left to sell. For AMR, the news was relatively good. Certainly AMR’s results – $390 million loss with special items – does not paint a pretty picture but at least one analyst thinks the company can avoid the bankruptcies credit agencies are predicting for other carriers. JP Morgan’s Jamie Baker wrote yesterday that “with $3.7 billion in unencumbered assets and a reassuring (if short-lived) credit card processing modification, we continue to view AMR's liquidity-raising takeoff roll as just beginning, whereas UAUA & LCC [UAL and US Airways Group] are viewed as considerably further down their respective runways with rapidly declining room for maneuverability.”

Baker was alluding to a recent deal with one of AMR's credit card processors limiting the amount of the reserve the processor can hold back from credit card receivables through the end of 2009. The maximum hold-back reserve, said the company will be approximately $300 million, including the $154 million reserve it had posted as of June 30, 2009, during this period.

And AMR bested expectations. Still S&P’s Equity Research expects Q3 revenue to drop 20% to about $5.14 billion compared to the year-ago period. Its 2009 loss expectations for the company is $1.27 billion, up sharply from original estimates of $840 million.

Analysts, reeling from the 17% interest rate on United’s latest fund raising, asked AMR about its rates. AMR managed to do 10% on the double enhanced equipment trust certificates in the public markets that gained it $520 million, according to Horton, who said, while that is not attractive financing by historical standards it is better than United.

Horton said the financial flexibility comes from $3.7 billion in unencumbered assets and other sources of liquidity including aircraft, Heathrow and other slots, American Eagle, and the potential value from a financing of its Advantage frequent flyer program among others items. As for AE, that depends on whether or not it can sell the subsidiaries since it took it off the market after trying last year.“With our other debt maturities this year, we expect to unencumber about another $500 million worth of collateral,” he said. “Our total debt at the end of the second quarter was $14.2 billion, down from $15.2 billion last year. Our net debt, defined as total debt less unrestricted cash and short term investments, at the end of the second quarter was $11.4 billion versus $10.1 billion a year ago, although last year we were carrying over $800 million in hedged collateral in our cash balance.

"I think there’s a distinction in the market place reflecting the fact that we do have considerable financial flexibility and unencumbered assets and degrees of freedom," Horton continued. "In a more normal capital market environment, we wouldn’t even be having this discussion.” Horton also reported the $66 million from aircraft sale-leaseback efforts accomplished. AMR ended the quarter with $3.3 billion in cash, including a restricted balance of $460 million. In the second quarter, scheduled principal payments on long-term debt and capital leases totaled about $400 million including the maturity of revolvers.
Analysts are especially interested in debt that comes due next year.

AMR continues to invest in fleet modernization with cap ex at $430 million. the $520 million ETC covers 16 of its Boeing 737 deliveries and four owned 777 aircraft for which the company has received approximately $150 million in gross proceeds to date, AMR reported continuing on with fleet plans. It is taking delivery of eight additional 737s, bringing total 737 firm orders to 84 during 2009 through 2011, including aircraft already delivered this year, and enhanced the terms of a committed financing arrangement for 737 aircraft. The financing enables the company to continue deliveries through 2011 rather than having enough money only for deliveries into 2010.

“That's what our fleet renewal program is all about,” Arpey told employees of the company’s plans, pointing to the second quarter deployment of the first wave of new 737s scheduled in the next two years. "In addition to new planes, we are continuing to prudently invest to refurbish aircraft interiors and airport facilities in a variety of ways. The new 737-800 burns about 35 percent less fuel per seat-mile than the MD-80 it is replacing, an average savings of 800,000 gallons of fuel per aircraft per year.”

“This is not growth, but the planes that we most recently also had financing associated with them, so there was a financing element there which made it attractive from our perspective to do, not just from a fleet renewal perspective but from a liquidity perspective as well,” Arpey told investors. “At 30,000 feet, the answer to your question is we are committed to building this company for the future and making it competitive for the future and making it competitive for the future, and to do that, we need to have a modern and fuel-efficient fleet, and so that’s what we’re trying to do.”

Industry Precursor
AMR’s results portend what analysts expect will be an industry-wide, second-quarter loss between $1 billion to $1.2 billion for the nine largest carriers. They point out that two price hikes have been accomplished this year balanced by lowered fuel charges and increased ancillary fees. Once again, Southwest is expected to be the lone profitable airline in the quarter.

Bloomberg reported that its index of 13 carriers dropped 44 percent this year with massive declines of 74% at US Airways and 70% at United. AMR has lost 70% of its value since last summer.

AMR Review
Its $390 million included $70 million in special items compared to a loss of $298 million and $1.1 billion in special items the year ago period for a net loss of $319 million ex special items. In the quarter, consolidated passenger revenues were down nearly 23%.

“Unit revenues declined approximately 16% on about 8% less capacity. Load factor was down by a half point, and yield was down nearly 16%,” Horton reported. “Driving these results were weakness in business travel revenue, which was down more than system average revenue, and the impacts of H1N1 which we estimate at $50-$80 million across the system, with a particularly strong impact to Mexico travel.” Delta has already announced a $150 million hit owing to H1N1.

International saw the largest decline with Atlantic, Latin, and Pacific operations all experiencing declines that were greater than 20%. Domestic fared better, but was still down nearly 12%. Given the weakness in business travel, trans-continental routes understandably saw the deepest unit revenue declines, down several points relative to the domestic average. Hawaii and Puerto Rico, both leisure destinations, with significant year over year capacity reductions, held up relatively well. Despite these effects, other revenue increased almost $40 million, or 7% versus last year.

Horton said second quarter unit costs, excluding fuel, rose by 5% mainline and 3.7% consolidated, driven by reduced capacity and headwinds from pension expenses and investments and dependability initiatives.

“The good news,” said Horton, “is that last year’s crisis in fuel prices has somewhat abated, and fuel prices are significantly lower than last year’s levels. Fuel price declines during the quarter were extraordinary. Our fuel price came in at $1.90 per gallon consolidated, a decrease of over 40% versus last year. Consequently, we paid $900 million less for fuel this year than we would have at last year’s price, driving total mainline unit costs lower by nearly 13%. Our second quarter 2008 fuel price of $3.19 per gallon was the second highest quarterly price we have ever paid for fuel. Combined with lower capacity, this translated into a decline in fuel expense of nearly $1 billion. That said, we are not assuming that fuel price concerns are behind us as prices have crept up from their first quarter lows and they obviously remain very volatile.

“We forecast a third quarter fuel price of $2.05 and a full year fuel price of $1.98 per gallon,” he continued. “With regard to hedging, we have about a third of third quarter consumption hedged with floors at $70 per barrel and caps at $99 per barrel on a crude equivalent basis, and a full year hedge of 36% of consumption with floors at an average price of $70 per barrel and caps at $97 a barrel. I’ll note that we use hedge accounting, and we’ll therefore see the full effect of hedging impacts in the period in which the hedge is settled, but under our current assumptions, we expect that we will see hedging impacts that add about $0.15 per gallon to our second half 2009 fuel price.

AMR said it was bucking the trend to replace mainline flying with regional aircraft. American Eagle, said Horton, experienced a quarterly revenue decline of about 25% versus the prior year. “We’ve continued to be disciplined with our regional fleet as well. Our regional capacity was down about 11% for the quarter, and unit revenue was down about 16% versus last year.”

With its announcement of further capacity reductions, AMR expects third quarter mainline and consolidated capacity down almost 9%. “We expect full year mainline system capacity to be down about 7.5% versus 2008, and we expect mainline domestic capacity for the year to decrease about 9%, and mainline international to be down over 4%,” said Horton. “The amount of capacity we’ve removed from the system over the last year or so has been noteworthy, somewhat masked by the magnitude of our capacity reductions in the fourth quarter of last year. So when comparing our second half 2009 capacity versus the same period in 2007, our mainline system capacity is expected to be 12% lower, with domestic capacity down over 15.5% and international down over 5.5%, so big capacity reductions.”

American’s capacity cuts are expected to mirror the industry. AMR announced last month it was increasing planned year-end capacity cuts by 7.5% compared to 2008. Advanced bookings are growing shorter. “We’re seeing some later booking than we have customarily seen,” said Horton, explaining Q3 advanced book load factors were 1.5 percentage points down from the year-ago period.

“Unfortunately that revenue is not technically the best revenues, so we’re still suffering from a negative mix effect, but clearly there has been some late booking, which is why our actual load factors came in a little bit better than we had guided to when we talked 90 days ago. I think I would say corporate travel has been off more than system traffic and system revenue, but it seems to have leveled off after the very sharp declines we saw at the end of ’08 and the beginning of this year, but the silver lining in the cloud. It remains sharply lower year over year, but it does seem to have leveled off a bit here in the May-June period.”

Arpey said at some point corporations will “realize their folks are not out there goofing off, they are actively generating business.”

“I see no evidence of that we would want to restore any of the capacity cuts we’ve made last year and the ones that we’ve announced this year,” said Arpey. “If anything, we continue to look at capacity in the other light in terms of whether we have done enough given the economic climate, but when you look at what we’ve done and you look at what the rest of the industry has done, both domestically and internationally, and some of the foreign carriers have moved pretty aggressively this summer, there has been a lot of capacity taken out of the industry, so I think if we can get any kind of economic recovery going, I think we and the industry are certainly much better positioned than we were a year ago, but I just think it remains to be seen whether we’ve done enough.”

Meanwhile Delta is cutting 5% of its international capacity and expects to cut staff as well. AMR announced a 1,600-employee staff cut. Citing the difficulty in reaching labor agreements, Arpey pointed out that AMR has the highest labor costs in the industry on average. “So there are things that we want to accomplish responsibly in our negotiations with all three of our labor groups, and there are things are organized labor wants to accomplish on behalf of their members, and so I think trying to find that right formula in balance has been challenging,” he said.

Continental, which yesterday announced it will take $44 million in one-time charges for the second quarter from the value impairment on 737s and parts as well as the sale of jets, added a percentage point to its previously announced plans to cut capacity by 5%. The Houston-based carrier requested 700 voluntary flight attendant leaves. US Airways said yesterday it was furloughing another 600. So far during this crisis that began at the beginning of last year, airlines have shed 31,700 jobs and 500 aircraft.