"No Longer on the Brink, American Air Is Still in Peril
By MICHELINE MAYNARD
From Today's New York Times Business Section:
Published: March 18, 2004
American Airlines has pulled back from the brink. Now all it has to do is figure out how to stay on top of the brutally competitive airline industry.
In the year since it skirted bankruptcy, American, the nation's largest airline, and a unit of AMR, has wrung $2 billion in concessions from its unions and surprised Wall Street by cutting its costs to 9.5 cents a seat-mile in the fourth quarter.
But it is still a long way from profitability. While its operating costs are the lowest among the major airlines, they are still significantly above the 5.9 cents a seat-mile at JetBlue Airways, the industry leader. American is also saddled with a crushing $21 billion debt, as well as ballooning pension and health care costs that it has few options to address.
It must contend, meanwhile, with feuding unions that are loath to cut it any more slack, stiff competition for customers from low-fare airlines, and jet fuel prices that have soared 15 percent in the last 12 months to slightly more than $1 a gallon, including an increase of nearly 4 percent yesterday alone.
On Tuesday, a UBS Warburg analyst reversed his full-year estimate for American from a profit of $1.05 a share to a loss of $1.20, citing the issues American faces.
At least mere survival is not one of them.
"We're no longer talking about the b-word; we're talking about our future," American's chief executive, Gerard J. Arpey, said in a telephone interview. But while bankruptcy is no longer American's immediate problem, Mr. Arpey has no illusions about the difficulties that remain.
"We recognize we dug ourselves a pretty big hole in the first years of this century," he said. The airline lost $1.5 billion last year, on top of $2.5 billion in 2002.
Analysts say the most difficult immediate problem is the rising cost of jet fuel, which threatens to erase the tiny net income that many said they had expected the airline to earn this year. Yesterday, American contended it still expected to cut costs this year, despite the spike in fuel prices.
To be sure, American is not alone in being hammered by fuel costs. Continental Airlines said last week that it did not expect to be profitable this year because of fuel prices, and Delta Air Lines raised its first-quarter loss estimate to $400 million last week for the same reason.
American also faces trouble with its unions. While it has talked glowingly of the cooperation it has received in the last year from employees, some of the union leaders who persuaded pilots and flight attendants to accept deep wage cuts as an alternative to bankruptcy have departed.
Further complicating the matter, the Aircraft Mechanics Fraternal Association said last week that it would ask a federal labor board to conduct an election in its bid to unseat the Transport Workers Union, which represents American's 12,000 mechanics.
The contest is bound to be lively, because the association's executive director, O. V. Delle-Femine, is a longstanding skeptic regarding airlines' pleas for cooperation. He has refused to sit on airline boards or sign confidentiality agreements that would give the union access to airlines' books.
"I'm not buying it," he said of American's bankruptcy threat last year. Were his union in place then, he would have told executives, "go before the judge and prove it," Mr. Delle-Femine said.
American contends it was ready to do just that. "We were as close to filing as you can possibly be without filing," Mr. Arpey said. "The papers were ready."
But American's chief financial officer, James A. Beer, says just as firmly that bankruptcy would have been worse for American than the measures it took to avoid Chapter 11.
While its $2 billion a year in labor savings is less than the $2.56 billion a year that United Airlines, a subsidiary of UAL, achieved under bankruptcy protection, American was spared the upheaval and scrutiny that a filing would have caused, Mr. Beer said. He added that United, which filed in December 2002, is still under court protection.
The concessions were not the only way American has attacked costs. Early last year, it began a top-to-bottom quest to overhaul operations, yielding $2 billion a year in savings in addition to the labor cuts.
Its search has gone as deep as the air filters on its jet engines. Instead of paying its old supplier $31.70 a filter, American found another company offering the same filter for $1.25, and got the government's approval to install it.
It has overhauled maintenance procedures at its repair base in Tulsa, Okla., where technicians no longer use drill bits once and toss them away. Its Boeing 777 long-range jets used to have two seating configurations - one for flights to the Pacific, the other for the Atlantic. They now have just one. Most important, American is down to 7 aircraft types, from 14 during the 1990's. It will be at six types when it finishes retiring its Fokker F-100 jets this fall. That saves on the cost of training and spare parts.
Such improvements are old hat to other industries, like automobiles and electronics. It is also the way things have always been done at the thrifty Southwest Airlines, the industry's low-fare leader.
But thrift was never essential to the big airlines, which covered costs by raising ticket prices. "It wasn't because we were stupid," Mr. Arpey said. "That kind of thinking just drove us in the 1980's and 1990's."
But that is no longer possible, in an era when low-fare airlines claim 25 percent of all domestic passengers. "It's becoming increasingly clear that to survive in this industry, you have to be vigilant on costs," said Darin Lee, an economist with the LECG Corporation, a consulting firm based in Emeryville, Calif.
Mr. Arpey, who is the son of an airline executive and a licensed pilot, is attacking his job with a drive that brings to mind the zeal of Robert Crandall, who was chief executive of the airline from 1986 until he retired in 1998.
But where Mr. Crandall stoked controversy, clashing with unions, and readily offering his blunt views on industry affairs, Mr. Arpey, 45, has been more low key.
He has done few interviews and made only a handful of public appearances during his freshman year as chief executive at the airline, where he has spent his whole carrier, having joined in 1982 after earning his M.B.A. from the University of Texas. One appearance was on Christmas when he went to Dallas-Fort Worth International Airport to greet passengers and employees. Another occurred Jan. 27, when he testified before a commission investigating the September 2001 attacks.
Mr. Arpey, who was in charge of flight operations when terrorists hijacked two American planes, called his predecessor as chief executive, Donald J. Carty, with the news. The pair monitored the events to their tragic conclusion.
Rather than dwell on the past, Mr. Arpey prefers to focus on American's challenges now, including low-fare rivals that threaten American's turf. "We will not retreat," he said.
In fact, more than two million people traveled American last year on fares of $150 or less, said Daniel P. Garton, American's executive vice president for marketing. And when JetBlue introduced transcontinental fares as low as $79 each way last year, American did it one better: it matched the fares, and offered "fly two, get one free" deals to frequent fliers from Boston and New York to California and Florida. Delta also matched the deal.
At American, more than 150,000 people signed up, including 30,000 new members of its AAdvantage frequent-flier program, said Mr. Garton. That easily justified the free tickets American will award this fall to those who took two trips. "It's icing on the cake," he said.
Yet even as American enjoys such moments, Wall Street is dubious. Philip Baggaley, airline analyst for Standard & Poor's Ratings Services, says American will have to spend nearly $2 billion in cash this year to pay its debts and invest in facilities and equipment. That is almost as much as the $2.6 billion in unrestricted cash it had on hand at the end of 2003. American said yesterday that it expected to have $3 billion at the end of the first quarter.
Mr. Baggaley, whose agency rates American's debt at B-, its second-lowest investment grade, said he was deeply concerned by American's pension and health care costs. They were not reduced in its negotiations with unions on concessions. The most effective way other major airlines have been able to attack those costs is to invalidate the obligations under bankruptcy protections, but that is the path American chose not to seek.
Mr. Baggaley, who has known Mr. Arpey since the early 1990's, said he believed that the American chief executive's work was just beginning.
"Even though he's been in the organization a long time, he's approaching it with a fresh set of eyes," Mr. Baggaley said. "He may indeed make some further changes. I don't think the story's over there yet."
Kevin P. Coughlin for The New York Times
American Airlines has won $2 billion in concessions from its unions and cut costs to 9.5 cents per seat-mile."