American Airlines parent AMR (NYSE:AMR) dealt a blow to other airline stocks on Monday when investors reacted to fears that the nation’s former aviation frontrunner might have to file for bankruptcy protection.
The company saw its stock tumble 33% — at one point falling to its lowest level in eight years. The report of an AMR Chapter 11 filing highlighted the weight its ancient cost structure has had on its ability to outperform rivals.
Meanwhile, other major U.S. airlines saw their stocks weaken on the AMR talk, reflecting another jab in an industry that has hardly been able to keep its head above water.
As economic woes, regulatory oversight and weak demand continue to weigh heavily on the troubled sector, some are saying an AMR bankruptcy may actually offer the industry a big boost.
“Unlike many analysts today, I believe an AMR bankruptcy is inevitable,” said Bob Herbst, an independent airline analyst and founder of Airlinefinancials.com. A court-supervised reorganization is likely within the next two to three quarters, he said.
Other industry analysts have placed the chances of a bankruptcy much lower.
“I don’t think it’s an imminent candidate; they have $4.5 billion in unrestricted cash on their balance sheet right now,” said airline consultant Bob Mann. “They still have a lot of furniture left to burn before they have to worry about not being able to heat the house.”
However, if history is any indication, an American Airlines bankruptcy might actually prove to be beneficial not only for the company but for the industry as a whole. AMR could emerge from Chapter 11 stronger and more nimble, with greater efficiencies, synergies and potential, just as its rivals did in the mid-2000s.
“All the other (airlines) are going to be a lot stronger because of that,” Herbst said. “I think anytime you make any company better it’s positive for the whole industry.”
AMR was the only major U.S. airline to not restructure a decade ago under court supervision, leaving it with older, costly labor contracts, while its rivals were able to renegotiate and significantly cut operating costs. The company also runs an older, less-efficient fleet, has struggled to get a solid return on investment from its joint ventures with British Airways, Japan Airlines and Qantas, and missed a consolidation wave in the industry.
All those challenges are on top of volatility seen industry-wide amid federal regulations, high costs and weak demand.
Filing for Chapter 11 would enable the company to reduce its debt load and refocus its cost structure, possibly making it a strong candidate for a merger, Herbst said.
United Continental (NYSE:UAL) became a powerhouse carrier and the biggest airline in the world earlier this year after Continental Airlines and United Airlines both underwent separate turnarounds under the court’s watch and then merged.
As with that merger, consolidations provide companies greater synergies and improved pricing power that many analysts say are essential for the sector’s turnaround. The most likely candidate for a possible merger with American would be U.S. Airways, Herbst said. Mann, too, suggested that U.S. Airways may consider a bid.
“After the reorganization, I think AMR will come back as a very strong competitor against Delta (NYSE:DAL), United Continental and U.S. Airways (NYSE:LCC),” Herbst said. “But it’s going to take some growing pains to get there.”
AMR said bankruptcy protection is “certainly not our goal or our preference.” The company went on to say that it knows it needs to improve its results, and remains “keenly focused” as it works to achieve that.
A Sector in Shambles
The industry has been in shambles this year as it struggles to make up for low demand amid high unemployment and renewed economic worries, as well as high fuel costs.
The International Air Transport Association [IATA] warned on Monday of a decline in the industry. Global air travel slowed in August amid a drop in consumer confidence, according to the industry group, while total passenger traffic fell about 1.5% from July. The U.S. saw the weakest advance in traffic in August at 2.9%, with U.S. domestic travel contracting 1%.
The IATA said that the August results are in line with expectations for a decline in profitability heading into 2012. Airlines are expected to see total industry profits fall to $4.9 billion from $6.9 billion this year.
“The industry has shifted gears downward. The pace of growth in passenger markets has dipped and the freight business is now shrinking at a faster pace,” IATA chief Tony Tyler said in a statement. “Airlines are bracing for tough times ahead.”
While demand has placed some pressures on the industry, its greatest struggles are costs, Mann said. Passenger tickets now account for just 71% of U.S. airlines’ total passenger revenue, down about 17 percentage points from 1990, according to the Department of Transportation.
Taxes, operating expenses, economic volatility and rising fuel costs have weighed on all airlines, forcing many to cut capacity over the last several months.
On top of that, high unemployment and dwindling consumer confidence have pushed leisure air travel lower, forcing many carriers to rely increasingly on their corporate clients. While airline tickets used by corporate travelers has been increasing, most recently seen in a 4% year-over-year gain in September, according to UBS analysts, relying on a lone revenue stream can prove risky.
“Current bookings data do not support the obvious pessimism in the market,” according to a research note issued by UBS analysts on Tuesday. “Of course the market is forward-looking and fear of an imminent corporate travel collapse is high.”
Since business travel is directly related to corporate profits, airlines are dependent on the overall health of the business environment. The UBS analysts said they expect airline revenue trends to decelerate.
Mann, who predicted leisure travel won’t improve until the overall economy starts performing at a “much higher level,” said corporate travel remains the “bright light” in the struggling industry.
“If it wasn’t, you wouldn’t see airlines making money,” Mann said. “The concern is, if the economy continues this downward trajectory, corporate profits won’t be good and you’ll see corporations rein in business travel.”
Government regulation protecting consumers has been an additional hurdle for airlines, as it forces carriers to maintain affordable fares while restricting their ability to charge fees for additional items such as baggage and entertainment.
The Department of Transportation put new rules into effect in August intended to enhance international travel for fliers by limiting tarmac wait times and compensating passengers for denied boarding. That mandate was met by criticism from Allegiant Air (NASDAQ:ALGT), Spirit Airlines (NASDAQ:SAVE) and Southwest, which claimed it is unlawful to force carriers to display government taxes and fees in their advertised ticket prices.
“We need to keep politicians out of airline industry,” Herbst said. “They put so many restrictions on (airlines) with the objective to make airfare as cheap as possible. But really it is at the expense of the industry.”
Airlines’ Right to Profitability
The bottom line, Herbst said, is that the government has to let airlines work on becoming better, rather than forcing regulations aimed at making air travel cheaper. After all, average domestic airfares, adjusted for inflation, have fallen 16% since 1995 including baggage fees, and 21% excluding those fees, according to the DOT.
If carriers were granted some freedom from regulation they would be able to increase fares while decreasing capacity, thus improving their pricing power and allowing them to reduce costs, Herbst says.
In a similar push across the pond, IATA’s Tyler urged the U.K. to consider expanding the reduction of the Air Passenger Duty across the region after it decided last week to reduce long-haul APD for Northern Ireland to short-haul levels.
“Reducing APD for Northern Ireland is a clear recognition of the economic damage that it does,” Tyler said. “To ensure that airlines can continue to catalyze economic activity, we need governments to review the often onerous tax burden that they place on aviation.”
Of course, cutting taxes for airlines and providing them more leeway to increase fares and fees would have inevitable consequences on the consumer side, such as initially lowering passenger demand. However, it would increase carrier’s flexibility, and many say that would ultimately lead to their long-term profitability.
“The airline industry was never meant to be a right of transportation,” Herbst said. “It’s something that’s for sale, and airlines have a right to be profitable.”
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