When I sat down with American CEO Doug Parker recently, I was told the interview was limited to talking about Los Angeles, so that’s you heard in the podcast. After we finished on that topic, however, Doug and I kept talking for awhile about broader issues facing the airline. I took the pieces of that conversation that were on the record and combined it with comments he made in the airline’s earnings call last week. The end result is this post… a look at why Doug says Wall Street is wrong about American.
For those who don’t pay attention to the financial side of the business, I should explain exactly what it is that Wall Street thinks about the airline in the first place. Right now, it is not happy. Just take a look at the airline’s share price performance this year.
Its shares have suffered mightily. Just over six months ago, the stock was trading near $60 a share. Now it’s in the gutter, barely above $30. The airline’s market cap is now shy of $15 billion. United is at $23 billion while Delta is at $36 billion.
Some of the reason for this is crystal clear. Its financial performance has lagged its peers, and there’s this perception that things are stagnant at the carrier. You have Delta continuing to lead the industry as it has for years. On the other side, you have a rising United which, frankly, had to rise since it couldn’t get much lower. That leaves American in the middle. Its operations slumped last year, and some product moves — pulling out seatback televisions, for example, and adding even more seats to aircraft — have created this perception that American is the laggard.
So why is that not right? Is American really in a good spot? Here’s how Doug explains it.
Margins are Low, But Good Growth is Coming
Looking at third quarter margins, American lagged its two biggest competitors by far. Delta’s pre-tax margin led at 13.5 percent. United was next at 9.7 percent, and American picked up the rear at 6 percent.
American has several initiatives underway to further reduce costs and grow revenues, but that all sounds like corporate speak that may or may not pay off over time. It’s also not unique. Every company has programs to drive growth in revenues and cut costs. What is special is something that is actually fairly unique to American. While the airline isn’t expecting to grow much, it has a great opportunity to grow in all the right places.
In each of the next three years, American will be able to significantly grow its most profitable hubs, and that’s not something that happens often. In 2019, American gets 15 new gates at Dallas/Ft Worth. In 2020, it gets 7 gates in Charlotte. And in 2021, the new regional gates open at Washington/National allowing the airline to upgauge from 50-seaters to 76-seaters. These are American’s three most profitable hubs, so the growth should be a very material boost to the bottom line.
That sounds good, and it will help revenue, but there’s a bigger issue that’s been bugging Wall Street.
An Enormous Amount of Debt
Debt is good in moderation, but Wall Street doesn’t like what it sees at American. Take a look at this chart showing American’s short + long term debt levels compared to the others, and you’ll understand why.
That is a whole lot of debt, and it keeps going up. Why? Well, you have to go back to before the merger to understand that.
Before the American/US Airways merger, American’s previous management team placed a gigantic order for a hundreds of new airplanes. Sure American needed to get new metal after years of neglect, but these were mega-orders that others probably wouldn’t have found wise to place. The capital expenditure (capex) required to support these orders is… big. To really put this into perspective, look at this graph of how much American has been spending on capex compared to other airlines.
That is a whole lot of money. The good news for American, however, is that this number is finally starting to go down after next year. It should drop below $5 billion in 2019, but then it’ll be down to $3 billion in 2020 and $2 billion in 2021. Then American expects it to stay between $2 and $3 billion annually from there.
Spending less money will allow American to pay down its debt when it comes due, and that’s good because a nice chunk will need to be paid off or refinanced in the next few years. But remember that this debt has been taken on in good times at good rates, so American is in no hurry to repay it until it’s due. It’s not the crushing high interest rate loans taken out in desperation as airlines have done in the past during lean times. American has said it mostly plans on repaying these, not refinancing them, when due. So debt will start to dwindle.
In the meantime, there is risk. If things get ugly quickly, then American will have a lot of debt that earnings in theory might not support. Because of that, American has built a buffer. The airline has been keeping a whole bunch of cash on hand.
If things were to get ugly, then American can dip into its cash and still have plenty of reserves. But could things really get that ugly? Doug has famously said that the airline will never lose money again, earning about $3 billion in weak years, $5 billion in average years, and $7 billion in good years. If that’s the case, then the debt really isn’t an issue.
Right now, however, those earnings ranges sound like a long-shot. Adjusted for special items, American is at $2.1 billion in earnings today, so that would make this on the lighter side of a weak year. All we hear is how the economy is booming and the revenue environment is strong, so this doesn’t sound right.
I asked Doug if he was looking forward to a downturn, so he could prove his thesis. But in Doug’s eyes, the thesis is already being proven. Sure, revenues are strong and the economy is good, but have you noticed the cost of a barrel of oil?
Jet fuel prices have climbed more than a third in the last year. Revenues may be strong, but there is huge cost pressure. In the third quarter alone, American saw a negative impact on earnings of $750 million versus last year. Yet here American is still posting healthy profits, just not as healthy as the others.
Does this mean Doug is right and Wall Street is wrong? I do think Wall Street is likely overreacting, and that share price feels low. Doug certainly has several valid points when he’s making these arguments. But there’s only one way for American to fix that perception… it has to prove it can do better.
31 comments on “Doug Parker Explains Why Wall Street is Wrong”
Is American gate-constrained at either DFW or CLT today? I know that they are surely looking forward to new slots at DCA, but are they *that* crowded at those other two hubs that getting even more gates will result in significant growth?
SirWired – Yes they are. That’s why they need the new gates.
For a contrasting point of view, read the article on View from the Wing, titled “SEC Filing Shows American Airlines Loses Money Flying, All Profit Comes From Frequent Flyer Miles”.
If you feel strongly pro or against AA, there is a convenient way to express your beliefs. Plus, you will be financially rewarded if you are correct. Go out and buy/sell the stock!
I would expect Gary Leff to come in and say something about his analysis, in response to CF’s post.
Gary claims (and documents) that AA profit comes from frequent flyer miles. Cranky looks at the total result, not where the profit comes from. They’re both right. https://viewfromthewing.boardingarea.com/2018/10/26/sec-filing-shows-american-airlines-loses-money-flying-on-loyalty-program-earns-profit/
If only Gary’s article include comparison with delta and united. I don’t think its a phenomenon unique to AA.
How does Southwest compare on those metrics against UA, DL, and AA?
I’m also interested in this.
I know that because of its business practices Southwest has traditionally not been considered a “major” or “legacy” airline, but given that it is 4 or 5 decades old, is (somewhat arguably) no longer a LCC in terms of pricing, and by some metrics it is as large as UA/DL/AA, I’d suggest that even with a different business model WN should be included (with proper context) in most comparisons of large US airlines.
As an aside, with the “legacy” airlines turning towards Basic Economy more and more, there may be a point (now or in the future) where one can reasonably argue that WN is the last major “full service” US airline for economy travelers. Irony indeed.
OuterSpaceGuy – I don’t consider Southwest really worth comparing in general because the airline operates a different type of business. It’s not low cost vs full service but rather domestic vs global. If there was a way to break out the domestic networks for the legacies, then it would be a helpful comparison, but there isn’t a way to do that.
Maybe that was true before Southwest did international service, but honestly: How many people want to visit (say) Auckland every day? Probably about 1 plane’s worth, I would guess. Maybe one plane per airline * only a few airlines?
Metrics like CapEx, short+longterm debt, cash on hand, etc… I think those comparisons would still be applicable, even if you don’t serve Auckland.
OuterSpaceGuy – This isn’t about whether one person flies to Auckland.
Southwest flies primarily Americans to American or close international destinations. That is a very different model than a global airline which has to deal with widebodies, lower utilization, currency issues, and more.
They are very different animals. But all this information is publicly available.
Income statement: https://www.marketwatch.com/investing/stock/luv/financials Balance sheet: https://www.marketwatch.com/investing/stock/luv/financials/balance-sheet Cash Flow statement: https://www.marketwatch.com/investing/stock/luv/financials/cash-flow
Their most recent earnings call should give you an indication of their current financial results
https://www.fool.com/investing/2018/10/25/southwest-airlines-earnings-tax-reform-profit-grow.aspx
Telling your investors that they are wrong is never a great strategy for any company.
American’s massive fleet spending has not resulted in higher revenues or lower costs to product the same amount of revenue as its peers. American does pay more than a half billion dollars more interest payments than Delta, United, or Southwest. That extra cost goes directly to the bottom line.
American could have afforded to pay for much more of its fleet renewal with cash from operations if it didn’t engage in the costliest stock buyback program in airline history – but their market cap has still fallen dramatically. AAL’s market cap was equivalent to DAL’s in the months right after the merger and AAL’s emergence from bankruptcy but AAL is now worth a fraction of DAL as a company. AALs debt didn’t have to grow as much if it gained a competitive advantage either via its fleet renewal or its stock buybacks – but succeeded at neither.
US airlines have typically spent a max of $3 billion per year on fleet; DAL is going slightly above that over the next few years but it is generating twice that amount in cash from operations. UAL’s capex is more modest but their debt is still increasing – but at lower levels.
All airlines are adding capacity from their best hubs. Given that much of American’s new capacity is being added for the purpose of picking up connecting traffic, there is no assurance that their revenues will grow as fast as other carriers or AAL’s own cost increases; a new cycle of labor negotiations for the industry could begin in a few months.
Just looking at forward P/E ratios it does appear AAL might be a little undervalued compared to DAL or UAL. That being said I’m an amateur investor and much more likely to follow the pros which are not rewarding AA with a high stock price. Years ago AA was my preferred airline. These days they are a distant 3rd option. I despise their connecting hubs, I can’t get 5 minutes of peace on a flight without another credit card pitch and although I fly them 1/10 as much as DL, they’ve made me late more than any other carrier. Parker can pontificate about the share price all he wants but he’s not done anything to turn me into a believer.
I’m curious how, if at all, you factor in what Gary posted the other day that American is actually losing money flying planes and its the airline’s miles selling program that is making it look good on the balance sheet because of accounting changes..
I believe that many investors have actually flown the airline and believe its on the same path as Eastern, TWA & Pan Am. It consistently ranks at or near the bottom of all DOT rankings, year after year, with no improvement. This was the case at US Airways too. Employee moral is also very concerning. Maybe investors like myself, want Parker out and new Customer focused Leader to take over.
BTW- my financial guy calls Parker this generations Carl Icon.
Naw. I think the airline industry here in the US has evolved to the point where two things we will never see again: the likes of a Braniff or Eastern type shutdown with mass strandings ensuing and two, ever seeing another new startup, along the lines of a Reno Air or a Midway. What we see now will be basically what we see for all perpetuity; save for the next round of mergers. I can totally envision the ten remaining (large) airlines combining down to just four.
It is possible for both Wall Street and Parker to be wrong. If AA keeps degrading its product, things are going to get messy really quick. I, for one, am tired of flying A320s and 321 with not seat entertainment and power outlets, in 3+ hour flights.
In this industry, does price competition still exist: AA vs. DL. vs. UA? legacies vs. WN? legacies vs. JetBlue, Alaska and the like? everyone vs. Spirit, Frontier and the like? Does product (economy) competition still exist: Our own operated planes vs. their contracted out regionals? Our experienced crews vs. their not so experience crews? Our own managed operations? Better seat pitches and seat widths? Wider cabin aisles and higher aisle ceilings? More carry-on capability? Etc. Or, is it skip the fare- and product-talk, make the money contracting out and get the loyalty charge card hook-ups?
The former management teams at American let the airline deteriorate to the point where the massive aircraft order was necessary. The airline is simply playing catch-up. Wall Street tends to focus on the short term. One of Southwest’s strengths is that it’s consistently focused on the long term. In my experience, American is no better or worse than the other airlines. Seats are getting more cramped and less comfortable across the board. Airline managements are not to blame for this. We are. Consumers tend to book the cheapest fare we can find. ULCC’s are the fastest growing segment of the industry. That’s not accidental. Airlines know their customers’ real spending habits. They collect massive amounts of data on consumer behavior in the real world, not what’s posted on airline blogs. I really think if American had its way, the company would be taken private. I also think some other airlines feel the same way. It wouldn’t surprise me if Warren Buffet bought a major airline in the not-too-distant future, just as he did BNSF.
> Consumers tend to book the cheapest fare we can find.
The facts show that this assertion is completely incorrect, otherwise DL (highest customer satisfaction of the US3) would not command a price premium over the other US3s exceeding 10%, and the sale of its most expensive tickets are increasing by 19% from a year ago. Even WN has a price premium too, even when you account the competitor’s nuisance fees (bags, change, etc.) when you compare apples to apples (i.e. back out premium cabin from its competitors).
This industry is like any industry: there is a demand for products, and pricing, at multiple levels, from bare bones cheap to high quality but good value.
> ULCC’s are the fastest growing segment of the industry.
When you start from zero, it’s easy to have high growth rates — and an irrelevant single digit market share. But they’re called ULCC now instead of LCCs for a reason: LCCs of yesterday (that time’s fastest growing segment of the industry) now offer the best business class in the U.S. (JetBlue is considered an LCC… go figure).
And yes, there will always be more Honda Civics sold than BMWs. But that doesn’t mean that every car manufacturer needs to go after the Honda Civic customer and produce only Honda Civic-like bare bone cars, which has been AA’s deeply flawed approach. The market isn’t stupid, and realize that this strategy will cost them billions in revenue discount on an ongoing, permanent, basis (who wants to pay the same amount to fly a DL screen-equipped wide seat A220 vs. an AA tight-as-they get 737-MAX8 or ‘densified’ 737-800? Yes, AA will have to discount its crap product).
Financial performance is always tied to customer satisfaction, as it presage the customer’s propensity to pay a premium for the product on an ongoing basis (i.e. in the ongoing future).
AA scores terribly in that regards, so it’s no surprise.
Why do the new regional gates at DCA matter? The regionals are currently out on hard stands connected to the terminal by buses. How does this restrict the aircraft size?
Bill – I think the issue is the gate area itself. If you’ve ever been to that gate they use, it’s a total zoo. They just can’t handle the number of passengers. At least, that’s what I’m assuming.
Ah yes, the dreaded 35X. That makes sense that it’s restricted by the boarding area, not the actual positioning of the aircraft.
So the regional gate area at DCA is similar to the regular gate area at MCI, in that both are congested enough that a fire marshal would run out of paper before he finished documenting all the room/building occupancy limit violations. Got it.
(I exaggerate, of course but not by much, at least not for MCI. Trying to walk in the gateside area of that airport is like trying to walk through subway cars at rush hour.)
Several people, including me, accused Brett of blatantly shilling for his buddies Parker and Kirby when they were (successfully) bidding to take control of AA during its bankruptcy proceedings. Brett assured us that he was confident the LUS management team was far superior to the old AA team and would fix all the problems at the airline, and to paraphrase Brett “I’ll be the first to criticize the new management team if their performance doesn’t measure up”. With the recent string of bad news (financial, labor, operational, customer service, etc) coming from AA, I kept waiting for Brett to chime in and take Parker and crew to task, but all we’ve heard from him is a bunch of puff pieces that gloss over these bigger issue. That’s why I was excited when I saw this morning’s post; I thought finally Brett is going to give a realistic critique of what has clearly been a poor management effort. After all, if wall street recognizes it, surely Brett must also.
Nope. Instead he just publishes Parker’s propaganda with very little push back or alternative analysis. We learned that the airline’s poor performance is due to a fleet acquisition decision made by the PRIOR management team, a rise in oil prices, from historic lows mind you, which AA’s management team didn’t foresee, and low margins caused by gate constraints at their most profitable hubs (apparently DAL and UAL have no such constraints).
Parker could have cancelled / modified the aircraft orders after he bribed the unions and gained control of the bankruptcy re-emergence plan, but he didn’t. Aircraft orders are cancelled all the time; Brett even reports on it. Also, getting the labor unions to back Parker’s team increased the airline’s annual labor cost by $1B, and the labor cost increases have climbed to almost $2B since then as Parker tries to buy ever elusive labor peace. How are those increased labor costs impacting AA’s margins? And yet there are ongoing labor problems at AA that, according to Brett, the merger was going to “fix”? What about the ongoing operational and customer service issues, and on, and on…
The fact is, this management team over-promised and severely under-delivered, and rather than staying true to his word, Brett continues to shill for them. But it’s not hard to understand why. Had Brett been more critical he wouldn’t get the special access that, just last week, allowed him to meet his childhood hero; Magic Johnson. But that access comes at a steep price; in this case, it’s Brett’s credibility.
To be fair, its not just AA that Brett shills for. Its most of the airlines.
Once the economy starts hitting rough spots, and we already are seeing rates go up and the stock market hitting some rough spots, AA is going to be in serious trouble. Oil prices are not that high and are more likely to rise than substantially drop.
The airline has substantial issues with employee happiness, and customers. I don’t fly much but it has been on AA and hearing employees, especially gate attendents really crapping on their airline doesn’t bode well for its future. The odds of seeing $60 a share isn’t going to happen for quite a few years.
“I don’t fly much but it has been on AA and hearing employees, especially gate attendents really crapping on their airline doesn’t bode well for its future. The odds of seeing $60 a share isn’t going to happen for quite a few years.”
If you flew more, I suspect you would be amazed by the incredible similarity in the experience of flying AA, DL, and UA (and I’ll throw in AS, too). For a typical traveller, the differences between these airlines are trivial. The experience is virtually the same. By looking at the numbers, you can see that DL runs a slightly better operation than the others, but I doubt you’d actually fly enough to notice (on DL, 16 out of 20 of your flights will arrive on time, with the other carriers it’s like 15 out of 20). And maybe the number of smiling flight attendants varies by 5% too.
As far as stock prices go, AA stock was at $59 earlier this year. The only difference in the company then and now is that, for 2018, they’ll make one dollar less per share than analyst thought they would make then. But they’re still making good money: $4.50 to $5.00/share — not bad for a company with a $32 stock price. Nobody really knows how much money they’ll make next year: frankly, the exact amount mostly depends on unpredictable oil prices. If you think the entire value of the company has “accurately” plummeted by 50% because FOR ONE YEAR they’ll make a buck less in profit, I might suggest buying index funds instead.
BTW, as far as oil prices not being “that high,” until their very recent pullback, they were up 50% in a year! On pretty much nothing fundamental. That’s about $2 billion to American’s bottom line. Not an easy number to overcome, especially when AA’s core int’l business — Latin America — is having a bad year.