Insight - US Results - Network survival

United is already in bankruptcy and analysts are worried by American as the US results just keep getting worse

So dismal is the year's final tally for the major US airlines that the uncertainty of war in the Gulf seems just an added insult to its already deep injury. For 2002, the passenger majors together produced a cumulative net loss of over $11 billion, worse still than the $7 billion they managed the year before.

Delta Air Lines president Fred Reid has talked about the crisis being an "extinction event" like that which wiped the dinosaurs from the face of the planet. Some of the US network majors do indeed look like a threatened species. Even excluding the special items and federal aid which continue to obscure the results, there is no mistaking that results from the majors worsened last year. Underlying operating losses climbed to nearly $7.5 billion. Airline managers now say they will be proud if they just get through 2003 breaking even. Of the 10 largest carriers, only perennially profitable Southwest Airlines has remained healthy through the industry's worst downturn in history.

The emerging winners in the big league of network carriers are those such as Continental or Northwest Airlines, which may make some money, possibly next year. For the rest, it is survival time. American Airlines sums up the problem. As a victim of the 11 September terrorist attacks, both literally and symbolically, it has seen traffic desert it, with its year-end 2002 numbers still down by 15% against 2000. And although seat costs fell over the year, its decline in passenger yields led the industry with a 9.3% fall.

With operating losses of over $2.6 billion and revenues down by nearly 9%, American's year-end results were on a par with those posted by United Airlines and US Airways, now both struggling to recover from bankruptcy protection. The group's net losses, excluding specials came in at $2 billion, of which $529 million came in the final quarter.

American's chief executive officer Don Carty calls the losses "unsustainable". As the carrier's chief financial officer Jeff Campbell, puts it: "No company can go on losing half a billion dollars every three months forever and expect to continue in business." Change the dollar figures and one could well and truly say that of the entire industry.

Carty says that American suffers from industry-wide forces more than others: it was designed for business travellers, more so than others, and so was hit by the business-travel downturn more than others, and can only slowly alter its hub-and-spoke system.

American, Campbell stresses, is increasingly exposed to low-cost competition, now in about 80% of its markets. But such exposure is widespread as the low-cost airlines expanded their networks by almost 10% in 2002, now flying 23% of all domestic capacity, up three percentage points from 2001. A glance at the figures being posted by Southwest, JetBlue and AirTran illustrate the gulf that has opened between the high-flying low-cost sector and the full-service network majors.

Whether or not American was hit harder or sooner than other traditional airlines is debatable, but it encapsulates the strengths and the weakness of the network carriers. Their weaknesses have grown so much that the possibility of bankruptcy is a probability. Salomon Smith Barney's Reno Bianchi, who watches the enhanced equipment trust certificates of parent AMR, says "the risk of a potential near-term AMR bankruptcy filing has increased appreciably" to 35-40% within the next 12-18 months.

Its decline has pounded both debt and equity; AMR shares have hit an all-time low, as its market capitalisation fell below that of low-fare carrier AirTran and its debt ratings fell to "junk" levels.

The group is looking everywhere for savings and says it is in talks with buyers for its AMR Investment arm which runs employee retirement assets and mutual funds. It envisions a price tag of $140-190 million.

At a premium

American, like every other carrier, deserves better. Campbell says the carrier can still get a 20-40% fare premium, depending on the market. "There's tremendous preference for American out there," he says. For American's sake, the higher range needs to be right. The Unisys R2A consultancy estimates that American's unit costs are at a premium of as much as 43% over those of Southwest.

Like others, American has to think about rivalling Southwest. Campbell refused to rule out the creation of a low-cost, low-fares unit, although he has to chose his language carefully as it is a sensitive issue for labour. American employees say they are certain such an effort is in the works and they point to low-cost developments already in progress at Delta and United.

Catching up with others, American has finally turned to the unpleasant business of demanding labour savings, having done as much as it could to save money by retiring large parts of its fleet, closing offices, and laying off managers before turning to its unions.

That may just be a smart move by Carty, who has spent much of his tenure working to overcome a legacy of labour enmity. But by the time in early February Carty formally went to labour to get $1.8 billion of the $4 billion on annual cuts American needs, the airline was headed toward an almost inevitable breach in late June of $800 million in bank covenants. Standard & Poor's Phil Baggaley, fearing the breach, estimates that "American has at most several months to conclude talks" on labour cost cuts, possibly even less time in the event of war.

The early responses of American's unions to Carty's plea for savings were encouraging - the pilots and flight attendants both agreed to negotiate, although suggesting they would resist permanent cuts or workrule changes. American pilots, in particular, remember the airline's introduction of the two tiered "B scale" wage of the 1980s, when those hired after a certain date advanced through pay rates at a slower pace than the earlier hires. This two-tier approach, which was a predecessor to creating a low-fares unit, led to deep resentments until it was ended in the 1990s.

Allied Pilots Association spokesman Gregg Overman said the union had "gotten a pretty full picture of American's financials" but would resist permanent concessions, because "we are not at all convinced that labour single-handedly sacrificing will pull all of the carriers through this current crisis". The board of the Association of Professional Flight Attendants voted to adopt a plan of action where the union would be willing to provide help to the airline on a limited scope and duration. It wants any relief it gives to American to be restored once the carrier is on a healthier footing. The union avoided using the word "concession", but said it is "committed to the survival of the company and recognises the importance to the membership of taking appropriate steps to ensure that the company is a viable and successful entity".

One analyst, CSFB's Jim Higgins, was encouraged: "Simply put, AMR's employees appear to get it." However, Merrill Lynch analyst Michael Linenberg puts odds of union concessions at evens. Given the constraints, American may have even less time than the other majors to ensure its survival.

DAVID FIELD WASHINGTON DC

Source: Airline Business