Airline Weekly - December 5, 2011

Cover Story

Thank Heaven for Chapter Eleven: But will it be enough for American? Or does it need to merge?

Maybe it was avoidable. Maybe it was inevitable. Either way, American Airlines voluntarily checked itself into bankruptcy, with two goals in mind: lowering labor costs and cleaning up the liability side of its balance sheet.

Make no mistake: American didn’t have to file—it went in with $4.1b in unrestricted cash. But with fuel prices still sky high, debt markets tightening and recession looming in Europe, the post-holiday lull period looked more and more menacing. Also, by filing now, American avoids paying a large amount of debt that comes due in December while protecting itself from creditors at a time of the year when cash flows are extremely weak: just after everyone has bought their holiday tickets and well before they start planning their springtime vacations.

Importantly, American’s decision to file with more than $4b of cash means it—unlike United, Delta and other airlines when they filed—could be able to finance itself through the restructuring period, an added boost to its debt cleanup effort. At the same time, American surely made its decision knowing full well that its chief rivals United and Delta are now thriving post-bankruptcy, albeit not only because of bankruptcy. And that its close partner Japan Airlines just used bankruptcy restructuring to engineer an incredible turnaround.

Will it work for American? Without a doubt, labor costs and interest costs—two areas where bankruptcy can work wonders—account for much of its recent underperformance. In its 2010 annual report, for example, American estimates that its labor cost disadvantage relative to other legacy carriers equals about $600m a year, a figure that would be higher still if LCCs were included in the comparison. In addition, labor contracts, specifically scope restrictions on regional jet flying, can have a revenue impact too. American’s interest costs, meanwhile, totaled $626m in the first nine months of 2011, equal to 3.5% of total revenues. United and Delta, by contrast, each paid interest equal to just 2.6% of their revenues. In those nine months, moreover, American paid off $1.5b in debt but borrowed another $1.8b. Its two larger rivals, by contrast, repaid a lot more than they borrowed, all while generating a lot more cash from operations. Put another way, American’s balance sheet has worsened this year, while the balance sheets of United and Delta have improved.

So American will now get to work addressing disadvantages in wage rates and health insurance, work rules, benefits for retirees and scope provisions for regional flying and heavy maintenance work. It might, as other airlines have done, move to terminate its defined-benefit pension plans and dump existing obligations on the government. It’s likely to cut jobs too, especially as it breaks leases... (463 of 1,854 words)

Also Inside this Issue:

If ever there was a week that highlighted the frustrations of the airline business, last week was it. American, of course, filed for bankruptcy, unable to convince labor unions of the need to lower costs. It was, according to Airlines for America, the 189th U.S. airline bankruptcy since 1979 and the 49th since 2000.

If that’s not enough to hammer home the difficulties of making money in this business, take a look at oil prices. The WTI benchmark rose above the $100 mark again, terrible news not just for airlines but for entire economies. For the U.S. economy in particular, expensive oil is kryptonite.

If bankruptcies and high oil prices aren’t disturbing enough, consider how unhelpful governments have become. The U.K. last week said it will raise its air passenger duty again this spring. Malaysia’s government-run airport company sprung a nasty tax surprise on AirAsia. Already-overtaxed U.S. carriers face potential hikes as well. And India’s government, in helping one hopeless airline (Air India), creates problems for everyone else.

Nevertheless, as 2011 nears its end, many airlines are alive and well. Spirit, for example—enjoying high profit margins—pounced on American moments after it fell into bankruptcy, announcing new routes on its home turf. AirAsia X, meanwhile, brought its low fares to Osaka.

Moves like that are forcing some strong carriers to play defense rather than offence. Singapore Airlines, for its part, announced destination number one (Sydney) for its new LCC Scoot.

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