The Third-Quarter Earnings Parade Gets Going

Madhu Unnikrishnan

October 25th, 2020

  • American was an early bull in the Covid crisis. As May turned to June, domestic travel demand was showing firm recovery, encouraging the carrier — which helpfully has a more domestic-heavy network than either United or Delta — to get aggressive. It restored lots of flights and seats to popular leisure destinations like Florida and the Rocky Mountain region. At the time, it planned to fly almost 60% of its normal domestic capacity for July.

    Sadly, the bullishness proved premature. Covid spread worsened, travel restrictions tightened, and summer demand proved less robust than anticipated. With the planning flexibility to reverse some of its capacity restoration, American didn’t wind up materially worse off than its peers. But nor did it do any better despite that advantageous domestic exposure. From July through September, the airline lost $2.8b net, excluding special items. Operating margin was negative 107%, almost identical to what United reported and a few points worse than Delta’s negative 89%. American indeed cut capacity less than either of its main rivals, with ASMs down 59% y/y. And its revenues were correspondingly down by less — they declined 73%. But operating costs dropped less too — down 40%.

    What matters more is how effective American is at using crisis-time opportunities to enact structural improvements — improvements that address the margin weakness it suffered before the crisis. To be fair, much of its margin weakness in 2019 and early 2020 stemmed from temporary labor unrest and B737 MAX disruptions, as well as heavy exposure to troubled South American markets. As late as 2017, remember, American’s margins were actually pretty strong relative to peers (it beat United that year).

    One important structural reform underway involves its fleet, with more than 150 planes disappearing for good amid mass retirements of A330s, B767s, B757s, E190s, and CRJ-200s. At the same time, all B737s will be standardized with denser layouts by early 2021, with the standardization of A321s completed by springtime 2022. As for widebodies, American is left with an enviable fleet of just B777s and B787s, the latter acquired on presumably favorable terms thanks to an especially close relationship with Boeing. The MAX remains an aircraft with great potential for American and should be flying again soon — possibly by late December, the carrier said. It currently has 24 MAX 8s and 76 more on order, with lots of deferral flexibility.

    The company regrettably felt the need to furlough 19k workers after a thus-far failed industry campaign to renew federal payroll support. Less grimly, it followed United’s lead in axing most domestic change fees and implemented some other customer-friendly improvements to its travel policies and loyalty plan.

    American likes the way its network is positioned now for multiple reasons. For one, four of its major hubs (Dallas DFW, Charlotte, Phoenix, and Miami) are in the U.S.’s demographically growing Sun Belt. Phoenix and Miami, moreover, are giant tourist destinations where traffic declines have been less severe. American is the largest airline in the Caribbean and upper South America, both hotspots for the sort of leisure and family-visit travel that’s leading the recovery. Management sure enough mentioned Sun Belt markets, Mexico, and reopened Caribbean spots as areas of “positive recovery.”

    Alliances will play a key role in lifting American from the industry depression. It has newly formed relationships with Alaska and JetBlue at home, supporting close ties to IAG, Finnair, Japan Airlines, Qantas, and China Southern abroad. Other new partners include Gol (replacing Latam in South America), Royal Air Maroc, and Qatar Airways. Just before the crisis, American showed an eagerness to open novel new intercontinental routes with help from its partners — Seattle-to-Bangalore, for example. Executives separately make the point that while corporate business is important and currently depressed, it’s not uncommon for leisure yields to be even higher in some markets, notably originating from coastal cities like New York and Los Angeles.

    That said, markets like New York and L.A. haven’t been big money makers for American historically. But now, these are becoming a smaller part of its network. Its DFW and Charlotte hubs in particular — supremely profitable in normal times — are representing a larger portion of American’s overall flying. It’s at hubs like these where the carrier can efficiently aggregate and distribute what little demand currently exists. It also claims these hubs are producing big yield premiums versus rivals right now.

    In other developments, American recently renewed a distribution contract with Sabre. It’s borrowing money from Washington, amplifying a huge cash stash. It has more debt that any of its peers but no large repayment obligations in the near future, and minimal capital spending commitments. It’s operating lots of cargo-only flights. Cash burn is coming down as demand improves steadily if slowly. Pre-flight Covid testing should soon give a boost to markets like Hawaii, the U.K., and the Caribbean.

    Last month by the way, 45% of American’s domestic flights were at least 80% full (this was the case for just 25% of flights in July). It means the carrier can actively revenue-manage on more flights, up-selling to higher fares. This is now the case for more than half of all domestic flights. The upcoming Thanksgiving and Christmas holidays should provide further momentum, based on experience from past holidays like Labor Day and July 4th. CEO Doug Parker is himself now flying multiple times a week.  
  • Southwest is anything but happy with a $1.2b Q3 net loss. Or with a negative 88% operating margin. But seven months into the industry’s gravest crisis, CEO Gary Kelly listed some of the things that do make him happy. One is that this Q3 red ink was a lot less than the company feared it might be three months ago, when early demand momentum suddenly reversed. He’s encouraged by improved momentum for Q4.

    Revenues are at least growing faster than costs. People and planes are getting back to work. Payroll support from Washington remains a real possibility. Southwest is playing offense now, adding new cities (see Routes section). B737 MAXs should be back in the air soon. Cash is plentiful, with capacity to borrow more if necessary. Revenues will get a further boost when middle seats are unblocked next month.

    The airline eyes a bigger slice of the domestic corporate market when it revives, aided by a new strategy of selling through GDSs. Kelly thanked his workforce for achieving excellent service and operational reliability throughout the crisis. He thinks that the worst might be over. And looking ahead, he thinks Southwest has the industry’s best business model for the recovery, featuring low fares, low costs, no hidden fees, immense scale, zero longhaul international exposure, zero premium exposure, a loyalty plan still performing relatively well, and a strategy to win more corporate business as it returns. Southwest remains the nation’s only investment-grade airline. And it decided against taking a government loan, securing capital on favorable terms elsewhere.

    Even so, without federal wage support, it’s now forced to do something very un-Southwest-like: It’s asking all work groups for a 10% pay cut for 2021, targeting $500m in savings. In exchange, it promises no layoffs next year. Unions though, like the Southwest Pilots Association (SWAPA), reacted coldly, citing various criticisms of management.

    Average daily cash burn will be about $12m this month, with revenues expected to be down roughly 65% y/y, which is similar to September’s decline. That said, there’s a modest pickup in farther-out bookings, notably for the upcoming holidays. Corporate travel revenues, though down 89% in Q3, are showing a few green shoots. Many shorthaul routes remain weak. Same for quarantine-imposing regions like the New York-area and New England. On the other hand, Southwest sees pockets of strength in southern California, intra-California, Las Vegas, Denver, Phoenix, Texas, and Florida. It mentioned signs of life in midcontinent cities like Chicago, Kansas City, and St. Louis as well. Hawaii demand, too, is beginning to come back as the state relaxes its quarantine requirements for travelers that test negative for Covid.

    Kelly acknowledges that some corporate travel might structurally disappear forever. As for potentially losing some cost advantage if others restructure more forcefully, Kelly invoked negotiations underway with Boeing, conducted to ensure “the lowest cost narrow-body operation in the world.” It certainty has leverage with Boeing, all the more so as it contemplates replacement for its armada of B737-700s (see Fleet section below). Kelly also expects all rivals to face scale-related cost pressures as the whole industry shrinks. Southwest, meanwhile, will be better positioned to grow capacity by winning a larger share of corporate business.

    Would another merger be in order? Right now, one wouldn’t make sense because buying any airline would entail absorbing huge losses. But the idea is “always on the table.”
  • Alaska Airlines held its Q3 operating loss margin to negative 75%, with revenues down 71% y/y but operating costs down only 37%. ASM capacity declined 55%. Like all other airlines, Alaska saw conditions improve from Q2 but not as much as originally hoped, and not nearly enough to curtail a daily cash drain from operations. It burned through some $4m a day during the quarter and won’t reach cash break even by year end after all — that was its target earlier this year. Demand, alas, never did continue the promising trajectory it was on in early spring, losing momentum during a summertime Covid spike. Alaska also expected to be selling middle seats by now. Instead, it felt it necessary to maintain the policy, which results in lost revenue on full flights. A third reason why it won’t hit cash breakeven this year is a recent decision to restore more capacity to Seattle, a move that might drain some cash initially but also leave it well placed to capture growing demand, especially from Hawaii.

    The Hawaiian market is important to Alaska, normally representing a double-digit percentage of total company revenues (it’s a critical driver of the airline’s loyalty plan success too). Well, good news. Hawaii is finally reopening to tourists, sans quarantine, who can show a negative Covid test. Sure enough, bookings to Hawaii are now increasing “materially,” getting stronger day by day. Alaska’s hometown Seattle, keep in mind, was one of America’s strongest and fastest-growing economies before the crisis. And the crisis is actually strengthening many of its top companies — think Amazon, Microsoft, and Costco (let’s forget about Boeing for now). Alaska is strong in other tech-oriented West Coast economies as well, like Portland and San Francisco, where many workers — if not traveling for business yet — are maintaining high incomes, eager to take vacations, and often choosing to work remotely from, say, a short-term rental home in Hawaii.

    Alaska more generally seems optimistic about Q4 and beyond, noting an increasing willingness for people to book tickets farther in advance. The latest Covid spikes, it notes, are far from urban centers along the West Coast. The upcoming holidays are attracting a decent level of new bookings. Alaska’s elimination of change fees is helping. Fare sales and promotions are increasingly effective, and even at loss-making prices, the airline sees evidence that just getting people back on planes for the first time will make them more likely to travel again. One promotion offers a whole row of seats for the cost of just one ticket. Another offers big discounts every time Seattle Seahawks quarterback Russell Wilson throws or runs a touchdown during home games (note: Entering the weekend, he led the league with 19 this year, albeit some on the road). Alaska’s loyalty plan continues to generate revenue through its credit card partnership with Bank of America.

    In the meantime, Alaska (like everyone else) is reorienting its network to be more sun and snow focused. It also responded to JetBlue’s Los Angeles offensive with new LAX routes of its own. In summary, demand is improving, and the crisis is progressively easing with each month’s conditions better than the last. Now, Alaska thinks it’s finally time to sell middle seats again, starting with Hawaiian routes in early January. This month, ASMs should be down about 45% y/y. But only when passenger volumes are down by something similar will Alaska be able to reach cash breakeven.

    Recognizing that the airline will likely be smaller for a long time, management wants to remove $250m from its fixed cost base, with the goal of achieving pre-crisis unit costs even while 20% smaller. Getting there required almost 800 involuntary dismissals, roughly half of them from the management ranks. It will also require higher productivity and cuts in overhead. Importantly, Alaska will have an opportunity to replace its higher-CASM Airbus planes with larger and more cost-efficient jets as leases expire. Alternatively, it could renew the leases at much more favorable rates. It has a fair number of B737 MAXs already on the way. And it’s considering a new MAX order, which at this moment could be done at extremely attractive prices.

    Looking beyond the current crisis to a time when Alaska’s corporate clients start flying again, a new alliance with American will enhance its marketing reach globally. So will its decision to join the oneworld alliance. Last week, Alaska announced a new arrangement with Microsoft and the biofuel provider SkyNRG, aimed at reducing carbon emissions when the software firm’s employees travel.

    One final word on Alaska’s balance sheet: Relative to the cash it has on hand, debt levels are actually unchanged from where they were pre-crisis. More specifically, it ended Q3 with $5.4b in debt but $3.8b in cash, for an adjusted net debt of just under $1.7b, exactly where it was at the end of 2019.

    Said CEO Brad Tilden: “No one knows what kind of weather we’ll have, but we can build a house to withstand the worst storms and also to take maximum advantage of the good weather when it comes.”
  • Aeromexico, which filed for bankruptcy on June 30, no longer holds a quarterly earnings call. But it did publish its Q3 financial statements along with some commentary. Obviously, it lost money during the period — $131m to be exact. But operating margin, at negative 77%, was at least a step up from its negative 253% drubbing in Q2. The carrier managed to produce $212m in revenues last quarter, down by 75% y/y but lifted by resilient cargo demand and a gradual restart of suspended routes both domestically and internationally. Operating costs dropped 51%.

    As discussed in last week’s Airline Weekly Feature Story about Volaris, Mexico is taking a relaxed approach on travel restrictions, even welcoming American tourists without any need to quarantine. There’s no restriction on air service either. Not all tourists are ready to come, fearful of the virus and deterred by quarantines imposed by their own governments when they return. But resorts like Cancun and Cabo are sure enough seeing y/y international visitor declines that aren’t as severe as in many other international markets. Domestic tourists are flying to resort cities like Cancun as well, sometimes working remotely from hotels there. Some hotels are in fact catering to remote workers and even schoolers — “Work and learn from paradise,” bellows one pitch. Guests even have access to onsite IT support.

    As Volaris mentioned, the cross-border migrant worker/family visit market has some life in it as well, as reflected in strong remittance flows. Aeromexico’s business, of course, has a large corporate and intercontinental component too, holding back its recovery. Its government didn’t provide much help, but management can breathe easier now with $1b in bankruptcy financing led by the U.S. investment firm Apollo, which also is supporting Avianca during its bankruptcy.

    Restructuring in court isn’t fun. But it can be a powerful tool to lower costs. Aeromexico negotiated more favorable leases on the majority of its fleet, which now stands at 107 B787s, B737s, and E-Jets. The figure includes six B737 MAX 8s still grounded. In the meantime, rival Interjet appears to be dying, Mexico City’s notorious airport congestion is less of a concern, and Delta remains a crucial partner.

    Aeromexico separately renegotiated its relationship with AIMA, which owns nearly half its loyalty plan — the carrier now has an option to repurchase that stake (good for seven years) if it’s willing to pay at least $400m. Gradually, the airline is reopening routes, including key cities in South America. It’s seeing “some recovery in travel.”  
  • As Aeromexico navigates the crisis in the confines of the courtroom, its low-cost rival Volaris is salivating at its future prospects. As it described during its Q3 earnings call, Mexico will see a reduction of 107 narrowbody aircraft due to the Covid crisis, which is a third of the entire country’s narrowbody fleet. The departing capacity also is equivalent to all 86 of its own high-density A320-family aircraft. Aeromexico and Interjet are the ones shedding the planes, and both are based at Mexico City’s main airport. Suddenly, slot scarcity there is no longer an issue, and Volaris is wasting no time in launching new routes from the capital. Since the start of the crisis, it’s opened six new domestic routes from Mexico City (to Villahermosa, Ciudad del Carmen, Torreon, Tampico, and Campeche), plus six new cross-border Texas and California routes (to Houston, Dallas-Fort Worth, Fresno, Ontario, San Jose, and Sacramento).

    Volaris, by the way, is now the number two player in Mexico City, behind only Aeromexico. Even so, some 40% of its routes network-wide compete only against long-range buses. For all its opportunities, the LCC does have near-term crisis management tasks to address, just like every other airline. Its negative 47% operating margin for Q3 was mild relative to the carnage seen elsewhere. But still, a negative 47% margin is a negative 47% margin. Net loss excluding forex gains was $107m. Demand among Mexican family-visit, migrant, and leisure travelers recovered faster than almost anywhere else outside East Asia, New Zealand, Brazil, and Russia.

    And this enabled Volaris to cut Q3 ASM capacity just 25% y/y. Revenues did drop 50% however, and operating costs just 11%. Operations, furthermore, are still producing negative cash flow, and that won’t change any time soon. Management in fact thinks cash break even might not come until late 2021, in part because it will have to catch up on aircraft lease payments it deferred the last two quarters. Q4 cash burn will likely be worse than it was in Q3. Still, demand is indeed trending up, allowing Volaris to avoid involuntary furloughs even without any meaningful government aid.

    Returning to the issue of future industry capacity within Mexico, there’s still the open question of when Aeromexico will get its B737 MAXs flying again. To be sure, Volaris benefited a lot from its rival’s missing MAX problem in 2019. As for its own capacity, the LCC will reopen its Costa Rica-based Central American unit late next month. In the meantime, ancillary revenues declined notably less than ticket revenues, boosted by new “combo” fares that allow passengers to add on individual services like priority boarding or extra bag allowance. Also helping: A new website and an upgraded Navitaire reservation system; Ancillaries represented 45% of Q3 revenue.

    Volaris expects to fly about 90% of its normal capacity this quarter, as it boasts of enjoying the “fastest airline recovery in North America.” Passenger traffic volumes, it believes, will equal 2019 levels by the end of 2021’s first half.
  • VivaAerobus, another Mexican ultra-LCC, looks a lot more like Volaris than it does Aeromexico or Interjet. Its operating loss margin was even a bit better at negative 41%, amid a 33% y/y reduction in ASMs and a 54% drop in revenues. Viva was able to get operating costs to decline 23%. Based in Monterrey and owned by a bus company, Viva, too, is eyeing new opportunities in Mexico City, and benefiting from Aeromexico’s bankruptcy and Interjet’s existential struggles. This month, according to Cirium schedule data, its seat capacity will be down just 10% y/y, compared to down 19% for Volaris, 44% for Aeromexico, and 93% for Interjet.

    At roughly half the size of Volaris, Viva has less scale. But it likewise plans to grow with new NEO planes, having recently received its first A321 NEOs.

    The Mexican airport operators OMA and ASUR by the way, in their own Q3 earnings calls last week, mentioned the new airport in Tulum south of Cancun that Mexico’s military plans to build and operate. They discussed Mexico’s traffic light system for advising citizens about Covid’s threat in different areas of the country (Cancun’s state Quintana Roo is incidentally at orange, signifying high risk). OMA mentioned Mazatlan, a Pacific beach resort, as having the smallest y/y traffic decline of any of its airports. On the other hand, business-heavy routes between big cities like Mexico City and Guadalajara are seeing some of the biggest declines. 

Madhu Unnikrishnan

October 25th, 2020