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MIAMI — American Airlines (AA) recorded a $1.49 billion net profit for the second quarter (Q2) of 2016, Friday, with results slipping 13.2% year-over-year (YOY) versus the same period in 2015.

Like many of its U.S. airline peers, American faced severe revenue pressures, with unit revenues falling 6.3% YOY and total revenue dipping 4.3% YOY. Perhaps accordingly, American was bearish on further growth and actually deferred delivery of 22 Airbus A350 wide bodies from 2017-2018 to the 2018-22.

American Earnings Highlights 

  • Operating Revenue of $10.36 billion, down 4.3% YOY
    • Passenger revenue down 4.4% YOY to $9.00 billion, cargo revenue down 10.4% YOY to $174 million
  • Operating Expenses of $8.61 billion, down 3.3% YOY
    • Labor expenses up 13.0% YOY to $2.67 billion
    • Fuel expenses down 25.9% YOY to $1.31 billion
    • Maintenance Expenses down 9.7% YOY to $453 million
    • Aircraft rent down 4.3% to $302 million
  • Operating Profit of $1.75 billion; operating margin of 16.9% vs. 17.7% in Q2 2015
  • GAAP Net Income of $950 million
  • Capacity up 1.9% in available seat miles (ASMs), demand up 0.9% in revenue passenger miles (RPMs)
    • Load factor down 0.5 percentage points to 82.9%
  • Unit revenue per ASM (PRASM) down 6.3% to 12.71 cents, cost per ASM (CASM) down 5.2% to 12.17 cents, CASM excluding fuel up 2.9% to 9.83 cents

Notes and Observations from American’s Quarterly Earnings Call

Starting with the Airbus A350 order deferral, it makes a lot of sense that American would defer wide body deliveries right now, given Latin America’s economic doldrums. American uses its Boeing 777-200ERs heavily to Latin America from its Miami and Dallas Fort Worth hubs, and right now it has too much capacity to sclerotic markets like Brazil and Ecuador.

With 787-9s also coming on property, AA simply did not have a need for additional 260+ seat aircraft in its fleet since the 777-200ERs are more than viable in the current fuel price environment.

The reality is that American Airlines is not pushing these deliveries too far back, instead of taking the first aircraft in 2017, they will take two aircraft in late 2018 and then five per year from 2019 to 2022. This will time shift about $1.2 billion of aircraft related capital expenditures out of 2017 and 2018, helping to boost results in those years.

The spreading out of those expenditures will actually make 2016 American’s peak year of aircraft capital expenditures, and even with debt markets cheap, we’d like to see American de-lever (or at the very least replace expensive debt with cheaper debt and/or bonds).

American negotiated a new credit card deal with Barclays, US Bank, Citibank, and MasterCard (existing partners), which will add $200 million incremental pre-tax profits in 2016, $550 million in 2017, and $800 million in 2018. The shift to revenue-based mileage programs has, as we predicted when Delta made its move, heightened the value of paid for miles as loyal but low revenue customers see earning drop sharply.

Of course, the big question with American has been revenue performance in the last several quarters. Domestic PRASM performance was strongest YOY in Phoenix and second strongest at DFW, but down 5.0% YOY overall.

Amongst international routes, PRASM performance was strong in Hong Kong, Mexico, Argentina, and Korea and weak in Japan, China. Brazil, after deep capacity cuts, showed an “improving trend” which implies a slowing of PRASM declines.

But overall performance was rough: down 6% across the Atlantic, 15% across the Pacific (admittedly on 21% ASM growth), and 10% to Latin America (despite deep capacity cuts).

Despite a more muted tone and a long soliloquy from Doug Parker on wanting to get back to positive Revenue Per Available Seat Mile (RASM) growth, we were glad to see American’s president Scott Kirby defend the carrier’s approach to nonstop competitors in markets like Dallas. “I think that there was absolutely no choice, but to compete and to match pricing of nonstop competitors, so just absolutely no choice,” said Kirby. “And it’s not a matter of vindicated or any other of those words. It’s what you have to do. And it’s what we have done and it’s the right strategy.”

Kirby also gave some more interesting commentary on the breakdown of market segmentation for airline revenues, that thanks to the internet and the comparison shopping it enables, the segmentation in terms of ticket flexibility between business and leisure travelers (for example requiring Saturday stays of the latter) is starting to disappear.

Interestingly, Kirby signaled that American’s approach to this problem is to compete instead on product segmentation.This has been a driver between American splitting economy class further into basic economy.

Here are some additional observations from the call:
  • Labor expenses are on a sharp upwards trend for American (13.0% in Q2) and bear watching in coming quarters.
  • Thanks to all of American’s share buyback activity, a 13.2% decline in absolute pretax profit turned into a ~7% increase in earnings per share.
  • Total RASM for the year is expected to be down 3.5%-5.5%.
  • American’s write down for Newark slots was about $20 million
  • Venezuela RASM is going to be down 35% YOY in Q3
  • Kirby reiterated American’s dislike of fuel hedges – we agree with their stance.
  • American thinks of Brexit as a mixed bag
    • Pound depreciation is bad, as 4% of American’s revenue are pound-denominated
    • Business uncertainty is bad and could reduce demand for premium cabin travel to London
    • American expects an increase in travel across the Atlantic for “consultants, lawyers, bankers that are likely to be flying back and forth, figuring out what the heck this means and what are we going to do.”