American Airlines' Top-Line Growth Is Decelerating While Costs Keep Climbing

Equity Analyst

Nicolas Owens

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Before the coronavirus pandemic, much of American Airlines’ story was based on realizing cost efficiencies from its 2013 merger with US Airways and strengthening its hubs to expand margins. While we observed a bump in operating margin to 15.1% in 2015, when the merger was financially consolidated and fuel prices dropped, American saw steady unit cost growth through 2019, when it delivered a 6.7% operating margin. While we expect American can achieve some operating cost improvement in the coming years, we do not expect it to structurally improve its relative position among airlines.

A pillar of full-service airlines' strategy before the pandemic was price discrimination between so-called business and leisure travelers. More-frequent and shorter-stay travelers who booked through their employers' corporate travel agency got bulk discounts for last-minute bookings and premium seats. The pandemic scrambled this formula as travel habits rapidly evolved: As airlines reengineer their ticketing systems and travel agency relationships to reflect the reality that business and leisure travelers can be the same person, we expect them to find new ways to attract and reward brand-loyal frequent travelers willing to pay up for a more comfortable travel experience.

Our outlook for U.S. airlines is quite rosy in the near term, though these companies are acutely governed by the laws of gravity and economics. As travel restrictions lifted in 2022, demand rebounded more quickly than airlines' capacity to meet it, constrained by shortages of planes, pilots, and other crew. As a result, airlines have recorded record revenue and profits. These conditions function as a boon to the whole industry, and we believe they will take until at least 2024 to even out. When they do, we forecast a return to more normalized operating conditions, which will erode airline profitability: When airplanes and personnel are no longer a constraint, we expect the incremental incentives that airlines constantly operate under to return to the fore, leading to competition over prices and market share anywhere their route maps overlap, which is almost everywhere.

Business Strategy & Outlook

Airlines rent out seats by the hour on aircraft designed to fly for decades, and their operations and financial results are subject to fluctuations in factors beyond their control, including ticket prices, fuel costs, labor costs, weather, and seasonal variation in people's travel plans. This business is highly price-competitive, capital-intensive, and labor-intensive, making it difficult for an airline to generate any profit beyond its cost of capital. Indeed, industry group IATA estimated in 2018 that return on invested capital had only approached the industry's cost of capital once in the preceding two decades and never exceeded it. Our own modeling reflects the same reality. We conclude that American Airlines does not have an economic moat.

What's more, the industry has been pummeled by three of the most severe global macroeconomic events of the last two decades: the 9/11 terrorist attacks, two global pandemics (SARS and SARS-CoV-2), and the Great Recession of 2007-09. In each case, air carriers experienced drastic and systemic disruptions to their operations, staffing, and financial viability, including bankruptcies and increased leverage. Similar macroeconomic events are likely to recur in the foreseeable future, and investors in airlines would risk permanent capital loss in such situations.

Airlines hire and train thousands of people with specialized skills, including ground crews, technicians, and air crews. They tend to plan their routes from a few months to a year in advance, and their costs for salaries, wages, and benefits usually total between one fourth and one third of revenue and tend to grow in tandem with their overall route capacity (measured as available seat miles). These costs are fixed in the short term but flex with capacity in the medium and longer term. Embedded in the cost of doing business as an airline, and exacerbating the challenge of staffing, is the strong seasonality of travel: Over the last 20 years, U.S. carriers have collectively faced a 30% January-to-June spike of monthly demand (or a 23% June-to-January slump), measured as aggregate monthly revenue passenger miles. International demand is more volatile and brings extra competition from non-U.S. carriers.

The most volatile expense an airline experiences is fuel. Although the amount of fuel required to power a given aircraft on its daily routes is known to the gallon (or by weight at takeoff), the price the airline will have to pay for that gallon can vary widely over a year, seasonally, and even regionally. Airlines were paying more than $3 per gallon of jet fuel (kerosene) in 2011, and fuel prices spiked in the 2022 aftermath of supply shortages as well as macroeconomic stress on the energy market caused by Russia's invasion of Ukraine. During 2011-15, jet fuel prices stayed over $2 per gallon, and airline yields—ticket prices measured in cents per passenger mile—approached $0.25 in the period. When jet fuel prices fell in 2016, airline yields did, too. The most important point about fuel is that each airline experiences its price more or less the same way; it is a commodity. And airlines have shown they can pass this element of their costs on to customers by charging more per mile when fuel prices are high. Over the long term, airline CPI—a measure of inflation—has been remarkably stable, notwithstanding a bit of a bump in 2022-23, which reflects the spike in fuel prices and which we do not believe will persist as competition heats up again.

The most costly competition airlines engage in is for aircraft. Every handful of years, Boeing and Airbus offer new models that can fly a bit farther or carry a few more passengers on almost the same amount of fuel. We observe a steady increase in the available seat miles per gallon consumed across all airlines as they consistently upgrade their fleets: The major U.S. carriers—Delta, United, and American—were able to fly an average airplane seat about 60 miles on a gallon of fuel in 2012 and are approaching 70 available seat miles per gallon in 2023; Southwest, which flies only variants of the narrow-body 737, went from 70 available seat miles per gallon a decade ago to approaching 80 in 2023. While this trend reflects ongoing improvements in engine efficiency, wing, and fuselage design, it also represents a competitive ratchet that no airline can afford to ignore. Multiplied over many hundreds of millions of seat miles per year, even a small difference in fleet efficiency would represent a structural disadvantage for an airline competing on the same routes. Thus airlines constantly refresh their fleet to stay competitive (new seats, bigger luggage trays, and the like are a side benefit of new planes that also may augment an airline's brand perception for a short time). 

Major U.S. carriers have partnered with a credit card issuing bank to promote loyalty programs that feature their frequent-flyer miles. For some, these programs, in which the bank pays the airline more for the miles up front than they are technically worth to redeem, represent the lion's share of ongoing operating profit. We do not see these programs as changing the competitive dynamic or structural profitability of an airline. The airlines have merely time-shifted when they experience the profit of serving one of their most loyal customer segments, in many cases redeeming miles for services such as baggage allowance, priority boarding, and lounge access, which cost incrementally very little to provide over and above the actual cost of the flight 

Airlines provide an invaluable service to their customers and communities, often stimulating the economies of those destinations they connect into the global travel network. However, investors in airlines are flying on a wing and a prayer, as we see no prospect for durable economic profit in this industry. Instead, the duopoly of Airbus and Boeing reap the economic reward from providing successively more efficient, powerful aircraft, which airlines line up to buy or rent so their service and cost profiles can keep up with competing carriers.

None

Economic Moat

American Airlines

PSA Airlines is an American regional airline headquartered at Dayton International Airport in Vandalia, Ohio,that flies under the American Eagle brand for American Airlines. PSA is a wholly owned subsidiary of American Airlines Group. PSA has crew bases in Washington, D.C.; Knoxville, Tennessee; Charlotte, North Carolina; Cincinnati, Ohio; and Dayton, Ohio. It has maintenance bases in Charlotte, North Carolina; Cincinnati, Ohio; Dayton, Ohio; Greer, South Carolina, and at the Akron–Canton Airport in Green, Ohio. As of April 2018, PSA Airlines employed 1,677 Pilots operating their fleet of advanced CRJ airliners. The airline operates 569 daily flights in 68 cities as American Eagle for American Airlines.

PSA Airlines

Envoy Air is an air carrier headquartered in Irving, Texas, in the Dallas-Fort Worth metroplex. It is a wholly owned subsidiary of American Airlines Group that, along with several carriers outside the group, feeds the American Airlines route network under the American Eagle brand. With over 800 flights a day, serving 150 cities across the United States, Canada, Mexico and the Caribbean, Envoy is considered to be one of the world's largest regional airline systems. Envoy is an affiliate member of the Oneworld airline alliance.

Envoy Air

Piedmont Airlines is an American regional airline operating for American Eagle, formerly US Airways Express. It is a wholly owned subsidiary of the American Airlines Group, headquartered in unincorporated Wicomico County, Maryland, near the city of Salisbury. It conducts flight operations using Bombardier Dash 8, and Embraer ERJ 145 aircraft. Piedmont Airlines, Inc. also provides ground handling and customer service for airports in the Northeastern & Western parts of the United States. Its main base is Philadelphia International Airport with an additional hub at Charlotte Douglas International Airport.

Piedmont Airlines

American Airlines Group, Inc. is a holding company, which engages in the operation of a network carrier through its principal wholly-owned mainline operating subsidiary, American. The firm offers air transportation for passengers and cargo. It operates through the following geographical segments: Department of Transportation Domestic, Department of Transportation Latin America, Department of Transportation Atlantic, and Department of Transportation Pacific. The company was founded on December 9, 2013 and is headquartered in Fort Worth, TX.

Earnings data Q1 2024

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