It was an earnings laggard before the Covid crisis. And it’s an earnings laggard now that the Covid crisis has passed. American Airlines again trailed its peers United Airlines and Delta Air Lines in profitability last quarter — and by quite a lot. Its third quarter operating margin was just 7 percent, compared to United’s 11.5 percent and Delta’s 10.7 percent.
What accounts for this underperformance? American itself is asking this question, in hopes of narrowing and eventually overcoming the gap. Its limited Asian footprint would suggest greater earnings power than its rivals right now. Ditto for its greater exposure to booming domestic and shorthaul Latin and Caribbean markets. American clearly has weakness, however, at its coastal hubs where it’s turning to JetBlue Airways and Alaska Airlines for help. It also has more debt than its rivals. And, interestingly, it expressed some envy of how much revenue United and Delta are squeezing from their loyalty credit cards, offered in tandem with leading banks. “They [United and Delta] produce $1 billion more to their co-brand credit card program. So we’re really focused on that because we think it’s a huge value driver for our customers, a very obvious one for us,” Chief Commercial Officer Vasu Raja said.
American seems to be taking the opposite approach to United with respect to its international ambitions. While its Chicago-based rival aims for ambitious growth abroad, American sees itself as an “80/20” airline, in other words, allocating 80 percent of its flying to domestic and shorthaul international routes. Longhaul flying, it says, has been a more volatile business over time, notwithstanding the current strength. Even so, American is introducing a new longhaul premium product and planning to take Airbus A321XLRs.
Operations have greatly improved. Boeing has started delivering 787s again. Dallas-Fort Worth and Charlotte are two of the industry’s most profitable hubs. And fourth quarter revenues should increase 11-13 percent compared to 2019, on 5-7 percent less capacity. One of the key themes of American’s third quarter earnings call: The new importance of what it calls blended travel, meaning people mixing business with leisure. This segment now accounts for an estimated 45 percent of the airline’s revenue, compared to 30 percent for truly discretionary travel, and 25 percent for pure business travel. Raja explained furthermore that blended travelers tend to fly more during what used to be offpeak hours, days, and seasons, prompting new approaches to schedule planning. In addition, among those flyers still traveling exclusively for business, the majority are with companies that do not have a corporate contract with American. These tend to be smaller businesses. In that sense, the world has changed. But American’s margin deficits have not. Can that change too?
United Posts Strong Q3 Margins
United was pleased to have beat Delta in the margin sweepstakes last quarter. Its 11.5 percent operating margin was fractions ahead of Delta’s 10.7 percent, not to mention just two margin points lower than what it earned in 2019. Delta, by contrast, did almost six percent worse on the operating margin front compared to then. Delta in fact grew its third quarter unit revenues more: up 34 percent from 2019, versus United’s 26 percent increase. But Delta’s unit costs swelled by 43 percent, versus United’s 28 percent. That’s partly because Delta’s capacity in ASMs was still 17 percent less than in 2019. United is still smaller than it was too, but by only 10 percent. And the degree of an airline’s capacity restoration roughly reflects its ability to efficiently utilize its assets and people.
United, to be sure, still has an asset utilization problem as well, especially with China and Japan that were still largely closed to visitors this summer. Japan just reopened though, and specific to United is the boost it’s getting from reincorporating Pratt & Whitney-powered Boeing 777s that were grounded for over a year for safety inspections. So that’s good news. Even better is the current state of demand, which continues to flourish even during the normally-offpeak autumn. CEO Scott Kirby insisted that seasonal swings are no longer so pronounced, a structural demand change he attributed to hybrid work and the flexibility it affords people “to make any weekend a three- or four-day weekend by working remotely for a day or two.” September, indeed, was one of United’s strongest months ever, and October looks even better. “This is not pent-up demand. It’s the new normal that hybrid work allows.” Added chief commercial officer Andrew Nocella: “Hybrid work gives customers the freedom and flexibility to travel for leisure more often.”
United, at the same time, still sees travel in Covid recovery mode, citing Japan’s reopening just this month. And critically, it sees supply constraints restraining the airline industry’s ability to grow for years to come. The airline industry, Kirby explained, is now 10-15 percent smaller relative to the economy than it was in 2019. “There is a real pilot shortage,” he said. “It’s going to take years to resolve … Boeing and Airbus are probably two to three years away from getting back to producing airplanes at the same rate. The air traffic control system, they do a great job at the FAA of trying to manage the system, but we have fewer controllers in the United States than we had 30 years ago [even though] we have tripled the operations.”
Supply running short of demand, while threatening to frustrate United’s growth ambitions, should at the same time lift yields, and perhaps margins. One area where United is growing rapidly is across the Atlantic, including new service to Africa and the Middle East. A new partnership with Emirates supplements a longstanding transatlantic joint venture with Lufthansa and Air Canada. And United now plans to implement a joint venture with Air Canada on transborder routes within North America as well, reviving an old idea that previously ran into regulatory barriers. Remember too that, unlike its peers, United never retired any widebodies during the crisis, giving it more flexibility to dial up international flying. On the narrowbody front meanwhile, it’s one of the largest buyers of Boeing 737 Max, having also ordered many Airbus A321neos (including some XLR versions to reach more of Europe from east coast hubs in Newark and Washington, D.C.).
Speaking of United’s coastal hubs, management said during its third quarter call that Newark and San Francisco still lag in terms of business traffic, with the tech and professional service sectors still underperforming (by professional services it means areas like banking, consulting, and legal work). Denver, by the way, was United’s all-star hub during the pandemic, benefiting from strong economic and demographic expansion, as well as its favorable geography for handling connections throughout the booming U.S. west.
United separately said operations are now running more smoothly than ever, following an industry meltdown this summer. Cargo revenues are still strong if cooling somewhat. Fuel costs last quarter were 64 percent higher than they were in 2019. Maintenance costs were 26 percent higher. And labor costs were only 7 percent lower, despite flying 10 percent less capacity. The outlook for this quarter? United told investors to expect fourth quarter operating margin excluding special items to be roughly 10 percent, which would exceed the 9 percent it earned in 2019. Finally, we can’t not mention Kirby’s verbal assault on ultra-low-cost carriers, prompted by a question from J.P. Morgan’s Jamie Baker. Kirby called the ULCC business model a “Ponzi scheme,” (whoa!) predicated on rapid capacity growth, packing people into planes, and levying excessive add-on fees unbeknownst to fliers until they show up at the airport. “I think that’s a doomed business model.”
Alaska, Aeromexico, and Icelandair’s Q3
Alaska, which tends to peak in the summer quarter, produced another excellent operating margin in the third quarter, reaching nearly 16 percent. That compares to 18 percent in 2019, when the airline was flying seven percent more capacity. Alaska’s home city of Seattle remains an all-star boom economy, home to companies ranging from Amazon to Microsoft, Starbucks, and not to mention Boeing. Speaking of which, Alaska is relying on the troubled manufacturer to deliver a slew of new 737 Maxes, enabling an accelerated transition away from the Airbus narrowbodies it inherited after buying Virgin America in 2016. Alaska insists — echoing the sentiment of many airlines this year — that “the biggest drag to CASM … for us this year is not producing the ASMs that we had wanted to originally,” Chief Financial Officer Shane Tackett said. Unit costs should drop, however, as recovery to 2019 capacity levels occurs sometime in the first or second quarter. “We’ve got a lot of aircraft coming in the first half of the year,” Tackett added. On the other hand, new labor contacts, including one with its pilots (see State of the Unions), are unequivocally inflationary. Fuel hedges helped margins last quarter, though Alaska still paid $3.66 per gallon on average, which was a bit less than United and American but a bit more than Delta (which owns an oil refinery). Open questions for Alaska are whether Boeing can get 737-10 certified, whether still-sluggish corporate demand revives along the west coast, and whether international demand starts flowing onto its network in greater volume. Alaska did, after all, join the Oneworld alliance, while forging close ties with American.
Aeromexico is surprisingly 18 percent bigger this quarter than it was in 2019, according to seat capacity data from Diio by Cirium. It did of course have major issues with missing 737 Max and Boeing 787 capacity pre-pandemic (due to Boeing’s production and regulatory issues). Absent sufficient government aid, Aeromexico was forced to file for U.S. Chapter 11 bankruptcy in 2020, triggering a court restructuring that ended earlier this year. The company has since moved to delist its shares from Mexico’s stock exchange, thus becoming a privately-held firm that no longer holds earnings calls. Even so, it disclosed its financial statements last week, showing a healthy 9 percent third quarter operating margin. This was two points better than it managed in 2019. Aeromexico recently retook ownership control of its loyalty plan, and reaffirmed its joint venture with Delta. It’s also taking advantage of booming demand to Mexican beach resorts led by Cancun. Frustrations linger about the new Mexico City airport that never was. But on the bright side, Mexico’s peso is not sharply depreciating like most emerging market currencies. That’s good news on the cost side, preserving some of the savings achieved in bankruptcy.
Icelandair had a great summer, scoring a 19 percent operating margin which handily beat its 15 percent figure from the third quarter of 2019. Demand for transatlantic travel has boomed since the start of spring and continues too into the fall. Some 43 percent of the airline’s passengers were flying on trips between Europe and North America last quarter, connecting via Reykjavik. Icelandair now wants to turn its home airport into a cargo hub, similar to its status as a passenger hub. That aside, passenger capacity should roughly recover to 2019 levels in the December quarter. Bookings remain strong “despite significant economic turmoil.” The strong dollar is, unsurprisingly, boosting U.S. sales. Premium demand is notably strong. And Icelandair expects a full-year operating margin between 1-3 percent for 2022.
In Other News
- The Lufthansa Group will report third quarter results this week. But last week, it gave a bit of a preview, telling investors to expect an 11 percent operating margin. It would have been roughly a point higher if not for labor strikes. Bookings, it added, remain strong. The airline also highlighted its declining pension liabilities, one nice benefit of rising interest rates (as rates rise, future liabilities shrink).
- Spirit Airlines shareholders, unsurprisingly, approved a more than $3.8 billion merger with JetBlue. The move is an important, if hardly final, step forward for the deal after JetBlue wrested Spirit away from Frontier Airlines in July. Now JetBlue and Spirit await a decision from the U.S. Justice Department, which must grant antitrust approval before the two airlines can merge. The carriers hope to close their combination, which would create the fifth largest airline in the U.S., by the first half of 2024.
- Mexico’s antitrust regulator, the Federal Economic Competition Commission, approved a plan by Allegiant Air and Viva Aerobus to form a U.S.-Mexico joint venture. The pact, which would be among the first such immunized partnerships between two low-cost carriers, was approved without conditions, Allegiant said. However, U.S. approval is still pending, and it is unclear if the Department of Transportation can grant it without an upgrade to Federal Aviation Administration’s safety rating of Mexico to Category 1 from Category 2. The FAA downgraded Mexico to Category 2 in May 2021; Mexican airlines are unable to expand to the U.S. and partnerships are limited as long as the country’s safety rating remains there.
- And in other regulatory moves, long-haul, low-cost Norse Atlantic Airways received a foreign air carrier certificate in the U.S. for its UK operating subsidiary, Norse Atlantic UK. Norse is expected to shift its existing flights between London Gatwick and New York JFK to the affiliate, and CEO Bjorn Tore Larsen said the authority will allow it to expand “our point-to-point route network between London Gatwick and the U.S.” next summer.
- In terms of partnerships, a number of new codeshares and interline agreements were unveiled last week. Latam Airlines and Virgin Atlantic applied to U.S. authorities to codeshare on flights between Chile, Colombia, and Peru, and the UK via U.S. points. The move came at the same time as the UK dropped visa requirements for travelers from Colombia and Peru. Air Transat and Porter Airlines launched their codeshare that covers select flights operated by the former from Montreal, and flights between Montreal and both Halifax and Toronto Billy Bishop operated by the latter. Hawaiian Airlines and Mokulele Airlines unveiled a new interline agreement to facilitate connections; the move follows Hawaiian’s decision to close its Ohana regional subsidiary in 2021. Since the closure, Mokulele is the only airline serving some of Hawaii’s smaller islands, including Molokai and Lanai. And WestJet and Pacific Coastal Airlines launched their own interline agreement covering regional dots in Western Canada. Pacific Coastal separately operates flights for WestJet under the WestJet Link brand.
- “We’re increasingly confident that aviation is returning to normal. So said Auckland airport chief Carrie Hurihanganui at a company shareholder meeting last week. The airport expects domestic passenger volumes to reach 85-90 percent of their pre-Covid levels for the current fiscal year that ends in June. International volumes should recover to about 60-70 percent. Executives stressed the importance of tourism to New Zealand’s economy. They mentioned new United and American flights to the U.S. In terms of building a second runway, management said that wouldn’t happen before the 2030s.
- For the airline industry to overcome the mammoth challenge of reaching net-zero emissions by 2050, it will need the help of entrepreneurs like Paul Eremenko. In some ways, Eremenko is an aviation insider, having served as chief technology officer of both Airbus and United Technologies (today part of Raytheon). Now he’s leading a startup called Universal Hydrogen, aiming to supply the aviation sector with clean hydrogen fuel. Appearing on the podcast “How I Built This” with Guy Raz, Eremenko outlined his efforts, which will start with providing hydrogen fuel capsules for ATR turboprops. The next target will be Airbus A320s and Boeing 737s, but they’d need to be completely redesigned to fly on hydrogen. That’s a high (and costly) bar for Airbus and Boeing, but Eremenko stressed that the industry — or humanity, for that matter — really doesn’t have a choice. Aviation will need to decarbonize one way or another, be it through innovation or contraction. Airbus, importantly, is an investor in Universal Hydrogen. So is GE and American. Of course, green hydrogen is still far more expensive than conventional jet fuel. And batteries? They are simply not a realistic alternative for large airplanes. So dictates the laws of physics and chemistry.