AA Experiences “Most Challenging Quarter” in Years; Reiterates Fares Must Increase

Jul 26, 2018

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American Airlines revealed its quarterly earnings Thursday morning. While these earnings exceeded analyst expectations, its pre-tax earnings dropped nearly in half compared to the same period in 2017, due to increased fuel costs.

In his opening remarks on the investor earnings call, AA CEO Doug Parker said this had been the “most challenging quarter” since the merger with US Airways. This was in part due to the 3,000+ flight cancellations the airline experienced when its wholly-owned subsidiary PSA Airlines had to ground thousands if flights because of a computer system failure.

However, the main drag on the world’s largest airline’s earnings came from a spike in fuel costs. Parker noted that fuel cost increases alone cost the airline over $700 million in pre-tax earnings. The airline expects nearly $2 billion in higher fuel costs in 2018 than it originally forecast.

In the discussion targeted toward investors, American Airlines management reiterated that it believes the airline is capable of its goal of $5 billion in pre-tax net profit — even if it has earned a little over $1 billion in the first half of 2018. Airline management insists that the recent spike in fuel costs shouldn’t prevent hitting this goal.

Instead, management doubled down on its belief that the airline can generate this level of earnings even if Brent crude oil costs $75 per barrel. While cost reductions can help the airline marginally toward this goal, the primary driver of these increased earnings can only come from one source: higher airfares.

In questioning from analysts and press, airline management would only say that it was “optimistic” that the airline can “recover the increased cost of fuel” and it sees “revenue more in line with fuel cost increase.” So far, airline fares in the US have only risen marginally even as fuel prices have jumped. When pressed on the timing of this cost recovery, Parker would only say that fares would have gradual increases — which seems to be inconsistent with the airline’s goals of hitting its stated pre-tax profit levels.

Joint Ventures

American Airlines is still seeking to form joint ventures with Qantas, Aer Lingus and LATAM. While insisting that these joint ventures will have a “material benefit” for investors (i.e. significantly more profits), Parker insisted that these agreements would provide “fantastic benefits for travelers.” While JVs could provide some cost benefits, it’s likely that they will be more beneficial to shareholders than to consumers.

For the Qantas joint venture, the airline says that regulatory approval “could happen this year.” AA management believes regulators are simply caught up on Aer Lingus’ “low-cost, low-fare” structure, delaying the approval until an “early 2019 decision.” For LATAM, AA is waiting to hear from a “Chilean tribunal,” and expects to need to file a new application once this approval is granted as the original application is more than two years old. Still, AA believes it’ll get a sign-up by the “second half of 2019.”

Aircraft Deferrals

In its quarterly earnings release, American Airlines disclosed that it’s deferring 22 Airbus A321neo aircraft, lowering capital expenditures by $1.2 billion over the next three years (2019-2021). This deferral is in addition to the already-announced deferral of 40 Boeing 737 MAX aircraft.

Responding to questions from analysts, AA management pointed out that it’s growing capacity while using the same number of aircraft. How’s the airline doing that? By squeezing more seats into hundreds of aircraft, through “Project Oasis.”

Further Segmentation?

While it was generally overshadowed by the other news coming out of the earnings call, AA management casually referred to “further cabin segmentation” as a way to help the airline’s bottom line. It’s hard to imagine how much more segmentation American Airlines could pull off. The airline already has seven different cabin segments: Basic Economy, Main Cabin, Main Cabin Extra, Premium Economy, domestic first class, Flagship Business Class and Flagship First Class. It’s hard to imagine what else the airline could do — but it seems management is hard at work considering the options.

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