ANALYSIS: American targets synergies after beating earnings targets

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American Airlines Group’s stronger than expected earnings in the fourth quarter are just the start for the carrier as it moves ahead with integrating its American and US Airways operating subsidiaries.

The Fort Worth, Texas-based carrier’s $292 million operating profit was ahead of most Wall Street analyst expectations for its first combined quarterly earnings after the 9 December merger. Operating revenue was up 8.7% to $9.98 billion and operating expenses 7% to $9.7 billion.

Jamie Baker, an analyst at JP Morgan, says the performance is a “strong profit base from which to begin tackling integration”, in a research note on 28 January.

Michael Linenberg, an analyst at Deutsche Bank, adds that the profit before special items was “well ahead of our net profit forecast”, in a report.

American reports a $1.95 billion net loss after $2.2 billion in special items and reorganisation expenses in the fourth quarter.

In addition to the merger, the legacy American operation emerged from Chapter 11 bankruptcy protection on 9 December 2013.

“The early returns on our merger are very positive," says Doug Parker, chief executive of American. "We have much work ahead, but believe we are on our way to restoring American as the greatest airline in the world.”

Passenger revenue per available seat mile (PRASM) rose 6% to 12.56 cents and costs per available seat mile (CASM) excluding fuel and special items increased 0.9% to 8.57 cents during the quarter.

For 2013, the carrier reports a combined operating profit of $2.58 billion on operating revenues of $40.4 billion. It posted a net loss of $1.23 billion after $2.66 billion in reorganisation and special items.

INITIAL SYNERGIES

American has already booked 70,000 joint itineraries across its two operating subsidiaries during the two weeks since American and US Airways began codesharing, says Scott Kirby, president of the carrier.

“We expect to start realising some revenue synergy value almost immediately,” he says. “To date, we’re exceeding our initial projections and are ahead on certain items like partner revenues.”

Kirby says that codesharing is expected to generate about a third of the more than $1 billion in revenue synergies from the merger.

American plans implement reciprocal codesharing across all of its operations by the end of February and move its US Airways subsidiary to the Oneworld alliance by the end of March.

Banking certain hubs, introducing variable scheduling at the American subsidiary and increasing seat density on some aircraft are expected to generate an additional $400 million in earnings improvements, says Kirby.

American will implement a banked schedule at its Miami International airport hub in its fall schedule, due out in the third quarter, he says. Similar schedules will be implemented at its Chicago O’Hare International and Dallas/Fort Worth International hubs in 2015.

Hubs at Los Angeles International and at New York JFK International airports will not be banked due to unique terminal and slot constraints, says Kirby.

The US Airways subsidiary hubs in Charlotte, Philadelphia and Phoenix already operate on banked schedules.

Variable scheduling will involve reducing the number of flights American operates on off-peak days, for example Tuesdays and Saturdays, compared to the number it operates on peak days like Friday and Sunday.

US Airways already operates with variable schedules. Kirby said a year ago that the airline was able to add an extra bank of flights at its Charlotte and Phoenix hubs based on demand on certain peak days.

Seat density will increase on Boeing 737-800 and Boeing 777-200 aircraft in the American subsidiary fleet. The 737s will increase to either 160 or 164 seats from 148 to 160 currently, says Kirby.

The 777s will increase to 260 to 289 seats from 243 currently, he says.

The increased densities will be achieved with slimline seats manufactured by Weber and the reconfiguration of the premium cabin on the 777-200s, according to American.

GUIDANCE SCRUBBING

American anticipates strong revenue performance despite increasing costs in 2014. It is targeting a 6% to 8% operating margin, which would be comparable to its 7.6% margin in 2013.

“I think we will outperform the industry this year on RASM [revenue per available seat mile],” says Kirby.

However, CASM excluding fuel, special items and profit sharing is expected to grow by 2% to 4% due to new labour contract costs, engine overhauls and other one-off changes in 2014, says Derek Kerr, chief financial officer of American.

CASM growth is expected to peak in the first quarter when it will rise 3% to 5%, followed by a 2% to 4% increase in the second and third quarters, and a 1% to 3% increase in the fourth quarter, he says.

However, executives warn that the guidance has not been “scrubbed” and is simply based on the respective budgets of both the American and US Airways operating subsidiaries.

“I think as we have time to dig through and understand both expense structures,” they say. “I think there will be additional opportunities.”

American expects its average cost of fuel to be $3 to $3.05 per gallon in 2014 based on 23 January prices, says Kerr. It anticipates paying $3.07 to $3.12 per gallon in the first quarter.

Mainline capacity will rise by about 3.5% as more aircraft return to service after maintenance, new larger aircraft replace smaller ones and the completion factor rises in 2014, he says.

American will take delivery of 83 aircraft in 2014, including 10 Airbus A319s, 42 Airbus A321s, three Airbus A330-200s, 20 Boeing 737-800s, six Boeing 777-300ERs and two Boeing 787-8s, according to an investor update on 28 January.

The airline will remove 74 aircraft, including four Airbus A320s, 14 737-400s – eliminating the type from its fleet – 19 757-200s, 12 Boeing 767-200s and 25 MD-80s.

On the regional side, it will add 43 aircraft, including 19 Bombardier CRJ900s and 24 Embraer 175s. It plans to remove 25 Embraer ERJ140s and two Bombardier Dash 8-100s.

Net capital expenditure of $2.1 billion, which is split between $1.2 billion for new aircraft and $900 million for non-aircraft purposes, is expected in 2014, says Kerr.