American Airlines may have yet to realise the full revenue benefits of its 2013 merger with US Airways, suggests Moody's Investors Service in a new report.
"American's inferior operating margins imply that the company has yet to capture the operating benefits of the 2013 merger with US Airways," the rating agency said in a credit opinion on 21 May.
Moody's expects the Fort Worth, Texas-based carrier's operating margin to lag peers Delta Air Lines and United Airlines by at least 350 basis points in 2019, it says. It cites American's significantly smaller international network – it only represented roughly 27% of revenues in 2018, compared to around half at its competitors – among reasons for this discrepancy.
American's pre-tax operating margin was 2.3% for the first quarter, its financial statements show. Delta reported a pre-tax operating margin of 9% and United 3.8%.
The suggestion that the American-US Airways merger has not lived up to its promises is likely to raise questions. When the carriers announced their merger on Valentine's Day in 2013, then-US Airways chief executive Doug Parker – now chief executive of American – and then-American chief executive Tom Horton outlined $1.05 billion in annual revenue synergies from the deal, a forecast that was raised to $1.45 billion by the beginning of 2014.
Financial reports indicate the airline has met those initial targets. Operating revenues increased by $5.8 billion to $44.5 billion at end-2018 since end-2012, its financial filings show. Operating costs have also increased, rising by $4.2 billion to $41.9 billion at the end of last year.
American declines to comment on the Moody's report.
The carrier's performance has slipped, both operationally and financially, in recent months to the point where JP Morgan analyst Jamie Baker asked executives last July if the carrier had fallen to a symbolic third place behind Delta and United.
"Our competitors are doing a nice job and one of them had a lot more upside than we did," said Parker in response to Baker's question. "But it doesn't mean we don’t think we're going to go do what we planned to do, which is to be the best airline in the world."
American is in the midst of a programme to boost revenues and margins. The majority of its roughly 2.5% capacity growth this year will be at Dallas/Fort Worth airport, which executives say is its most profitable hub and expected by analysts to boost margins more than growth elsewhere.
In addition, the carrier is in the later innings of its product segmentation programme that includes basic economy fares and an international premium economy cabin. It completed the installation of the latter on its widebody fleet, save the Airbus A330-300s and Boeing 767s it plans to retire, in April – well ahead of United's end-2020 target and Delta's end-2021 goal.
Moody's expects these and other commercial initiatives to contribute roughly $900 million to American's operating income in 2019. This is expected to produce a "modest" improvement in operating margins.
American still faces operational and cost challenges. Morgan Stanley warned in a report on 20 May that, with 80% of its union contracts up for renegotiation in the next 18 months, the airline could face a 5-10% jump in labour expenses by end-2020. In addition, an alleged slowdown by mechanics plus the grounding of its 24 Boeing 737 Max aircraft have led to thousands of flight cancellations to-date this year.
The carrier also remains the most highly-levered US carrier, according to Moody's. Its debt-to-EBITDA ratio stood at 5.4x at the end of March, and is expected to decline to roughly 4.7x by year-end.
The rating agency does not expect American to pre-pay debt and instead to use free cash flow to fund share repurchases.