American Airlines’ Margin Squeeze: Needs Union Deal to Cut Routes

November 11th, 2011 by Tim Brugger
6.19
Trefis
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AMR
Alpha Metallurgical Resources

With Q3 behind them, several airlines have a lot to be happy about; others, not so much. Unfortunately for American Airlines (NYSE:AMR) they are sorely lacking compared to competitors in one critical area, so much so it may require a serious look at some of AMR’s less profitable routes. Operating margins are a good gauge of how efficiently management runs a company. And with razor thin margins to begin with, it can be particularly interesting to see how airlines stack up. For the last quarter at least, Alaska (NYSE:ALK), Delta (NYSE:DAL) and United (NYSE:UAL) led the pack with margins of 12.1%, 10.5% and 10.4% respectively [1].

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Margin Squeeze

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With a Q3 operating margin of a mere 0.6%, American is well behind the pack in this key area and has been for several quarters running. Such a disparity is not difficult to explain: American Airlines has the highest labor costs in the industry. In large part, the overhead is due to not filing bankruptcy as so many airlines have in the past. Those airlines were able to re-negotiate with their unions as a result; no such luck for AMR though reportedly a deal could be close with pilots.

Route Review Would Help Margins, but Fee and Cargo Revenue Would Take a Hit

Notwithstanding a deal, such thin margins would necessitate a review of under-performing routes and markets. While it may be one way to shore up operating expenses, it would be intriguing to see what impact it would have on what American does best: generate Ancillary Fee and Cargo income.

Nearly 35% of the $6 Trefis price estimate is derived from these sources. The impact of eventually cutting unprofitable routes to help margins might very well be a step in the right direction. The question for investors is how much to adjust American’s ancillary fee and cargo income, an area of strength for AMR.

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Notes:
  1. Airline Financial Data, Airline Data and Analysis [↩]