For the past year or so, American Airlines' (AAL 0.61%) top management has spent a lot of time talking about making culture a competitive advantage. American has faced a fair amount of labor discord in the past, so the company's leadership wants to reenergize front-line employees, with the ultimate aim of improving customer service.
This is an admirable goal. But unfortunately for American Airlines shareholders, it mainly seems to involve spending a lot of money in order to make sure that employees never get upset about their pay. Considering its plunging profitability, the company can ill afford this expense.
A big tax reform bonus for American Airlines employees
On Tuesday, Southwest Airlines (LUV 2.01%) announced that its board had authorized a $1,000 cash bonus for every employee. Southwest was following the lead of various other companies in celebrating the recently passed tax reform bill by giving employees a bonus.
Later that day, American Airlines announced that it, too, would pay a $1,000 cash bonus to every employee. Management estimated the cost of these bonuses at $130 million.
Yet American Airlines won't actually see a tangible benefit from the tax reform bill for many years. While it will be able to report a lower tax rate on its financial statements, the tax bill has no near-term impact on American's cash flow. The company is sitting on more than $10 billion of net operating loss carryforwards related to its pre-bankruptcy losses, and until those are exhausted -- sometime in the 2020s -- it won't owe any cash taxes.
That's quite different from Southwest Airlines' situation. Southwest has been profitable for more than four decades, so it pays taxes every year and will see huge cash savings starting in 2018.
A familiar situation
American Airlines' decision to pay $1,000 employee bonuses represents yet another instance of the company writing a big check to smooth over potential labor issues.
Most notably, last April the company gave its pilots and flight attendants a significant pay boost to reach industry-best levels -- even though neither work group's contract was due to expire until late 2019/early 2020. That decision immediately increased costs by $350 million annually.
Incidentally, while American Airlines has been incurring all of these extra costs in an effort to please its employees, employee satisfaction isn't exactly stellar. The company's Glassdoor rating of 3.8 puts it in the middle of the pack: ahead of most low-cost carriers, but well behind industry leaders Delta Air Lines and Southwest Airlines.
American Airlines can't afford these incremental costs
If American Airlines were extremely profitable, ensuring that its employees always had industry-leading pay might be a good long-term strategy. However, American's adjusted pre-tax margin probably fell to less than 9% last year, down from 12.6% in 2016 and 15.3% in 2015.
American is likely to face further pressure on its profitability in 2018. The company expects non-fuel unit costs to increase a very reasonable 2% year over year. However, the price of Gulf Coast jet fuel has spiked higher in the last few months, surpassing $1.90/gallon in late December. That's more than 20% higher than the full-year average price for 2017.
Unless fuel prices subside, American Airlines will need to increase unit revenue by about 5% this year just to hold its profit margin flat. That will be tough to accomplish, given that the carrier faces some of the toughest year-over-year unit revenue comparisons in the industry.
Additionally, while American Airlines had nearly $2 billion of excess cash (above its $7 billion liquidity target) at the end of 2016, its fourth-quarter earnings report will probably show that it has exhausted most of this cushion. Thus, American's decision to pay $130 million of bonuses to employees will force it to further reduce its capital return program in 2018 -- making American Airlines stock even less enticing for investors.