Following several years of financial losses and industry under performance quarter-after-quarter; last November 29th, American Airlines (NYSE: AAR) joined the long list of previously bankrupt airlines.
“There is a 95% probability American Airlines will be merged within 18-24 months and the most likely merger partner would be US Airways”.
fully expects that a merger of American Airlines and US Airways (NYSE: LCC
) will occur. Due to the size of United (NYSE: UAL
) and Delta (NYSE: DAL
) –over 50%– of US market share, there is no way the DOT/DOJ would approve either of those airlines becoming larger with American assets.
Further, we believe without merging, both American and US Airways will face major challenges moving forward as they attempt to compete against Delta Airlines and the merged United/Continental Airlines.
This report provides in-depth analysis to support our position above.
Before looking at the current airline environment, let’s look at how the airline industry was just a few short years ago.
In 2007, American Airlines was by a measurable amount, the largest airline in the United States.
When comparing 2007 capacity (ASM’s), American was at least 14% larger than United and Delta and, significantly larger than all other competitors.
American was the industry’s revenue leader in 2007.
Fresh out of their own bankruptcies, Delta and Northwest Airlines merged in October 2008 creating the newest largest airline in the World. Not to be left behind, in September 2010, United and Continental Airlines merged to become the newest biggest airline in the World.
Fast forward to year 2011 and American had gone from largest to third largest airline in a relatively short time period.
Southwest merged with Air Tran in May 2011, pushing their mostly domestic capacity within reach of American’s and well ahead of US Airways.
As the chart shows, the cumulative total of American capacity and US Airways would top the industry.
As a side note. 2011 US airline capacity is little changed from what it was 12 years ago pre 911.AirlineFinancials.com
disagrees with forecasts that show measurable increases in passenger traffic. We expect higher fuel prices and labor cost increases supported by industry consolidation, will provide the incentive and pricing power so that airlines can increase passenger fares to a high enough level to make consistent industry profits. As such, higher fares will discourage measurable passenger growth for the foreseeable future.
When comparing total revenue (includes regional affiliate income), the merged United and Delta are now 45-60% larger than American and significantly more than twice the size of US Airways. Combining the revenues of American and US Airways would move the merged carriers to the top of the largest airline in the world list.
Comparing aircraft fleet sizes, merging American and US airways would give them, by far, the largest fleet in the industry.
Let’s backtrack a little and see a short summary of when American found their way to financial failure.
Prior to the recent industry consolidation, American was able to carry a revenue premium over their major/network competitors.
As the chart shows, American’s passenger fare yield premium started to deteriorate in the first half of 2010. US Airways revenue performance declined over the same time period.
believes the mergers of Delta/Northwest and United/Continental provide those merged carriers pricing power above what either American or US Airways can achieve. Due to their significant larger global route networks, Delta and United were able to “poach” more-and-more of the higher fare premium/business passengers from both American and US Airways.
When comparing passenger revenue per available seat mile, the same conclusion can be found for the loss of revenue premium for American and US Airways.
Looking forward, what are the pros and cons for an American and US Airways merger?
The first issue is to look at capacity (ASM’s).
As the capacity chart for 2011 shows, American and especially US Airways are significantly smaller than both Delta and United.
When combining American and US Airways, the merged carrier is slightly larger and very competitive with both United and Delta.
Market share breakdowns for large hub airports show American/US Airways with the largest share of domestic and Latin capacity.
The Atlantic segment capacity would still have Delta and United measurably ahead of American/US Airways. But with the domestic feed combined from American and US Airways, it is likely additional Atlantic capacity could be supported.
The weak point for American/US Airways is the Pacific markets. Beyond alliance partners, the only solution for American/US Airways in the Pacific is future internal growth.
One of the longer-term questions for American and US Airways is, how do they achieve domestic traffic feed to support the typically, higher yield international markets?
When looking at the recent 2011 domestic traffic data, a combined American/US Airways would have the highest market share at eight of the largest US airports.
Specific to the New York area, American has 17% of the US domestic market at both LaGuardia and JFK airports. This is enough market share to competitively support American’s current JFK international route structure (see JetBlue comments below).
The relatively high passenger yields at all of the major airports where American/US Airways have large hubs and significant market share supports one of the very positive outlooks for a merged American/US Airways
Worth noting is US Airways and American’s largest domestic hubs, Charlotte and Dallas, have the first and third highest passenger yields of any major airline hub.
On the international side, American/US Airways provides service to the most Latin destinations and is somewhat competitive in the Atlantic segment.
Growth in the Pacific segment should be one of the clear objectives for American/US Airways.
Currently, neither American nor US Airways have the aircraft to competitively serve the Pacific segment. However, both airlines have a large number of long-range aircraft on order and within a few years, will have one of the most competitive, long-range fleets in the industry. In the meantime, American, through their One-World Alliance can provide service to nearly all of the Pacific markets.
American and US Airways are at opposite ends of the “labor cost” spectrum for the airline industry. Using either unit labor costs and/or labor costs as a ratio to operating expense/revenue, American is higher than all industry network competitors and US Airways is the lowest.
See comments below for how labor costs will become a competitive positive for a merged American/US Airways.
Airline expenses can be broken into three major categories.
- Fuel expense
- Labor expense
- Core costs
Core costs are what are left after deducting fuel and labor.
US Airways, driven in part because they have a smaller network, consistently record the highest core costs.AirlineFinancials.com
believes a merger of American and US Airways would reduce their core costs by a significant amount. In fact, American has the lowest core cost ratios of all network carriers.
Working out the numbers-
In the end, any merger of American and US Airways must provide legitimate support for a competitive and profitable airline. AirlineFinancials.com
believes that can and will occur and here is why:
- Reducing US Airways core costs to what American currently has would provide $500-$700 million in cost savings synergies. Note American’s core costs are likely to go down at the other end of their bankruptcy reorganization
- American’s current labor costs, via the bankruptcy reorganization, are likely to be reduced by $700-$800 million per annum
- American’s capital/financial costs due to reorganization are estimated to be reduced by $300-$500 million per annum
- The merging of American and US Airways will be a much stronger global competitor to both United and Delta. We estimate this will provide the needed incentive to regain some premium/business revenue increasing annual revenues by 1-2% ($350-$450 million per annum)
- Due to the older age of both American and US Airways pilot groups, pilot labor costs into the future will become 20-30% lower. Note: Over the next 5-10 years, thousands of the most senior pilots for American and US Airways will be forced to retire. They will be replaced by significantly lower cost new pilots.
- Aircraft orders for both American and US Airways will move American from having one of the oldest most fuel/maintenance inefficient fleets to one of the youngest and most fuel efficient fleets. Fuel expense will be reduced by 10-20% as the new aircraft replace the current old fleet.
Total cost saving synergies = $1.8 – $2.5 billion accretive within 12 months of merger. Does not reconcile future savings from new fleet fuel savings and lower pilot costs. These savings will be offset by an approximately $600 million expense to bring US Airways labor up to parity.
Potential business model changes-
American has effectively lost the New York market to United and Delta. However, American still has enough market share and international operation further supported by the One World Alliance to maintain their current market share, especially with O&D traffic (see below on JetBlue).
JetBlue is frequently considered a potential merger partner for American. While JetBlue has a large number of JFK landing/take-off slots. Merging JetBlue with American does not “fix” American’s major problems long-term. Noting the above, American/US Airways could lock into a code-share agreement with JetBlue that would add significant passenger/revenue feed to American’s JFK international markets.
Removing US Airways from the Star Alliance and adding their network to American’s One World alliance would add dozens of new destinations to One World partners while weakening United’s Star Alliance.
Phoenix (PHX) is a large metropolitan airport with a single airport and two primary airlines. Excluding US Airways flights to Hawaii there are no flights to the Pacific region. Market/operational studies should be done to see if Phoenix could be used as a profitable connecting gateway to the Pacific bypassing the often flight delayed LAX airport and LAX competition.
Charlotte and Philadelphia are major international gateways for US Airways; it would be logical to expect these two hubs to grow as international traffic bypasses JFK and is connected through these two airports providing a much better consumer experience than what JFK frequently provides.
Both American and US Airways are operating with at or near maximum load factors. As such it is unlikely their merger would cause reductions in labor forces (excludes American’s current reorganization planned labor reductions and mid to upper level management positions).
For far too many years, American employees have focused on management as their primary and only enemy. While every other network airline experienced similar to American, obscene management bonuses, concessions, pension losses, bankruptcies, mergers, and furloughs etc. The employees of American’s competitors, while fighting withtheir management, never lost sight that their real enemies were the competing airlines trying to take as much market share -and jobs- as they could from competitors. For a merged American and US Airways to become long-term successful, American’s labor groups will have to understand and more so, accept, their real enemies are theother airlines doing all they can to take their passengers!
Conclusion- In every -potential-transaction there is a consequence to doing it and there is a consequence to not do it.
The merger of US Airways and American has far more positive benefits than negative ones and their merger would play a major role in making the US Airline industry better!
History shows a long list of once great airlines that failed. Each of those failed airlines had one thing in common. They all failed to remain competitive. It’s the opinion of AirlineFinancials.com
that American and US Airways must merge to remain long-term competitive.
Unless stated otherwise, data is for mainline operations. Some data may be estimated and is subject to errors.
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Disclosure- The above opinions and comments should not be used to determine the worth of any stock or investment. At the time of writing, the author and his family did not hold stock and/or derivative positions in any of the airlines covered in this article.
Robert Herbst is an independent airline industry consultant. He is the founder of AirlineFinancials.com
which provides airline industry analysis and commentary for major US carriers. In addition to his consulting work, Mr. Herbst was a commercial airline pilot for over 35 years. His aviation experience and financial background provide a unique analytical perspective into the airline industry.