5 Things American Airlines Group Inc.'s Management Wants You to Know

American Airlines Group Inc. executives see more good times ahead for the largest airline in the world.

Aug 23, 2014 at 10:53AM

Late last month, American Airlines Group (NASDAQ:AAL) reported that it earned the highest quarterly profit in its history during Q2. From a financial perspective, the company's merger with US Airways has been very lucrative thus far.

On the company's conference call, American Airlines' top executives talked about a variety of issues related to the company's merger process and global demand trends. Here are five key points that American's management wants investors to know.

The merger integration process is on track

"It's sometimes hard to remember that just less than eight months ago, American was in bankruptcy and getting ready to emerge from bankruptcy through our merger with US Airways. Yet today, here we are reporting record profits. ... There's a tremendous amount of work ahead, as we all know. But what we do know is this performance is evidence that we are on the right track and it gives us confidence as we move forward." --Doug Parker, American Airlines CEO 

Airlines American Us Airways Merger Aal

American Airlines is making good progress on its merger integration. Photo: American Airlines

It is still very early in the American Airlines-US Airways merger process. The main integration activities that have occurred so far have been the implementation of code-sharing between American Airlines and US Airways, harmonization of their frequent-flier programs, and combining airport operations like check-in counters.

Even with fairly small changes, American Airlines has seen a significant improvement in its profitability simply from gaining scale. Cost synergies will start to arrive next year, helping the company keep unit costs roughly flat in 2015.

Meanwhile, American Airlines is just starting to implement initiatives to boost unit revenue. These include reworking hub schedules to allow smoother connections, redeploying aircraft across the combined American Airlines-US Airways network, and focusing more flights on peak days/times.

Air travel demand is high throughout the world

"As far out as we can see, we expect the domestic environment to remain strong and I would even say, the international environment is strong." --American Airlines President Scott Kirby

Most U.S. airlines have been reporting very strong demand for domestic routes in the past couple of years. Capacity discipline has helped drive domestic fares higher, leading to record earnings across much of the U.S. airline industry.

However, American Airlines' management team emphasized that air travel demand is very strong outside of the U.S. as well. That said, international unit revenue trends have been weaker as many airlines (including American) are adding flights between the U.S. and the rest of the world.

Nevertheless, it's much better to have strong demand and modest overcapacity than to have less capacity and weak travel demand. American Airlines is cutting some international capacity for the fall and winter in order to bolster unit revenue trends going forward.

American's expansion in Asia is succeeding so far

"When you look out, you have 10% capacity growth across the Pacific. We have even higher capacity growth and we are going to have RASM [a measure of unit revenue] up. That is huge revenue growth." --American Airlines President Scott Kirby

In June, American Airlines started new routes to Hong Kong and Shanghai from its largest hub at Dallas-Fort Worth International Airport. The addition of these routes will drive dramatic transpacific capacity growth starting this quarter, as American was beginning with a fairly small footprint in Asia.

Airline American Airlines Plane Aal

American Airlines' growth in China is off to a strong start. Photo: American Airlines

Typically, this level of growth would hurt unit revenue, as long-haul routes take a few years to "mature." Nevertheless, American Airlines expects to grow transpacific unit revenue in Q3, a testiment to the strength of demand.

That said, the jury is out on how Asian unit revenue will hold up looking out to Q4 and beyond. Last fall, American Airlines canceled an unsuccessful flight from New York to Tokyo's Haneda Airport. This means comparisons will get tougher beginning in late Q4. Additionally, Q3 is the peak travel season -- it won't be quite as easy for American to fill its new flights to Asia in the fall and winter.

Venezuela's currency issues are a major headwind -- for now

"In the third quarter of last year, Venezuela was only 0.5% of AA system capacity, but would have been 2% of our total combined consolidated revenue. This year, we've canceled most of our Venezuela flying ... which means that our system PRASM in Q3 is negatively affected by almost a full 1.5% ...." --American Airlines President Scott Kirby

Last year, Venezuelan travel demand was artificially inflated by a loophole that let Venezuelan nationals exchange money at a favorable rate if they traveled abroad. (The dollars they received could then be resold for a profit on the black market.)

Venezuela's government has cracked down on this activity. It is also refusing to help airlines exchange Venezuelan bolivars for dollars. American Airlines has historically been the leading carrier between the U.S. and Venezuela, and so it is experiencing the biggest negative impact from Venezuela's currency problems.

Now, American Airlines is dramatically cutting back service to Venezuela to reduce the risk of currency losses. However, these flights were extremely profitable last year, so the service reductions will depress unit revenue in Q3 and Q4. The impact will peak in Q4, when the Venezuelan flight cuts could reduce American's unit revenue by about 2 percentage points.

It's too early to estimate the impact of Southwest's expansion in Dallas

"We don't see anything in our numbers yet that's identifiable, but we know there will be an impact from [Southwest Airlines' expansion in Washington D.C. and Dallas]. The Wright Amendment impact will be larger than in D.C., but we aren't seeing anything yet." --American Airlines President Scott Kirby

Airline Southwest Airlines Plane Luv Boeing

Southwest Airlines' growth in Dallas will create a drag on American's unit revenue beginning this fall. Photo: The Motley Fool

Southwest Airlines will expand later this year in two key American Airlines hub markets: Dallas and Washington D.C. Southwest's growth is enabled by the phase-out of restrictions on long-haul flights at Dallas Love Field and the airline's acquisition of flight slots at Reagan Airport in Washington, D.C.

The introduction of meaningful competition on a number of routes that American Airlines currently dominates will clearly have a negative impact on unit revenue. American Airlines executives stated on the recent earnings call that they expect the biggest impact on point-to-point travel in Dallas.

However, the Love Field flight restrictions don't expire until mid-October. As of last month, it was still too early for American Airlines to estimate the impact of new competition from Southwest Airlines. Investors will have to wait until October for more information.

Foolish bottom line

By and large, American Airlines had an extremely successful spring quarter, and Q3 is shaping up to be strong as well. The merger integration process is beginning in earnest, and it should deliver even bigger benefits starting this fall and heading into 2015.

This is great news for investors, because American Airlines may also start to feel unit revenue pressure from its growth in Asia and Southwest Airlines' expansion in Dallas starting later this year. Merger synergies will hopefully enable American to keep its earnings stable or growing despite these headwinds.

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Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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