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Even with an uncertain economic environment and increasing fuel costs, most of the U.S. aviation industry experienced a profitable 2012, largely due to a strong consumer demand. As reported by American Airlines, annual industry passenger revenues and yields increased by 3.8% and 3.2%, respectively, compared with 2011. Increasing costs of operations and an increase in taxes left little room for carriers to show improvements in the performance. As can be seen from the table below, profitability was generally derived from improved efficiency in operations.

2007

2008

2009

2010

2011

2012

Load Factor

(% of Seating Capacity Utilized)

79.90

79.50

80.40

82.10

82.00

82.80

On-Time Arrivals

(% of Domestic Flights within 00:15)

73.40

76.00

79.50

79.80

79.60

81.90

Involuntary Denied Boarding

(per 10,000 Passengers)

1.12

1.10

1.19

1.09

0.82

0.99

Mishandled Bags

(per 1,000 Domestic Passengers)

7.05

5.26

3.91

3.57

3.39

3.09

Flight Cancellation

(% Scheduled Domestic Departures)

2.16

1.96

1.39

1.76

1.91

1.29

Source: Airlines for America

In the U.S. aviation industry, almost every major airline has filed for Chapter 11 bankruptcy since 2002, including United, Delta (DAL) and US Airways (LCC). Similarly in the late 2011, American Airlines (AAMRQ.Pk) filed for Chapter 11 bankruptcy due to rising labor, increasing fuel costs and mounting levels of debt. The company is in the process of restructuring under the guidance of the Bankruptcy Court and has recently announced that it has come to a merger agreement with US Airways.

Recent Developments

Both, US Airways and AMR Corporation have recently experienced operational problems, but of dissimilar nature. The fact that AMR Corporation is in Bankruptcy clearly indicates that it has seen some difficult times. However, the problems for US Airways are not so apparent. AMR Corporation although has got a good liquidity and financial position, but it suffers from inefficiencies in its operations, which has been forcing it into losses. US Airways, on the other hand, although has seen its operational efficiency peak in the most recent fiscal year but suffers severely with the lack of liquidity and sources of financing.

In this article, I will initially identify and elaborate the problems these companies are facing and then explain as to how the merger would help the companies in overcoming the identified problems and what could be expected of the post merger company.

US Airways Group, Inc.

Ever since its emergence from bankruptcy, US Airways has seen stable growth in revenues and Profits with FY12 turning out to be the best year in terms of profitability and operational performance in the history of the company.

2008

2009

2010

2011

2012

CAGR

(5-Years)

Revenues

12,118

10,458

11,908

13,055

13,831

Growth (YoY)

-13.70%

13.86%

9.63%

5.94%

3.36%

Net Income

-2,210

-205

502

71

637

Growth (YoY)

90.72%

344.88%

-85.86%

797.18%

81.14%

Source: Morningstar

The company has achieved a CAGR of around 3.36% in the revenues over 2008-12 and has seen a growth in net income of around 81.14% over the same period. This is substantial given the general economic downturn, fierce competition and the fact that a significant portion of the company's flights is over short distances, making the company more susceptible to competition from surface transportation, such as automobile and trains.

The company has also been able to improve its operational efficiency since 2011, as depicted in the table below:

2012

Departures

RPM

ASM

Load Factor

Air Cargo

401,000

46,071 million

53,783 million

85.70%

131 million

2011

Departures

RPM

ASM

Load Factor

Air Cargo

403,000

44,511 million

52,476 million

84.80%

157 million

Source: US Department of Transportation

The company was able to increase its Revenue Passenger Miles, Available Seat Miles and Load Factor despite operating lower amount of flights in 2012. The company handled the lower amount of cargo; still it was able to achieve a revenue growth of 5.94% in 2012, indicating growing passenger revenues. The company was also able to improve its yield by 0.57 cent, to 16.78 cents in 2012. Similar increasing trends were also seen in company's passenger revenues per available seat mile and the total revenue per available seat mile.

in USD Millions

2012

% of Total Operating Costs

Total Operating Costs

12975

100.00%

Aircraft Fuel and Related Taxes

4587

35.35%

Salaries and Related Costs

2488

19.18%

Aircraft Rent

643

4.96%

Aircraft Maintenance

672

5.18%

Other Rent and Landing Fees

556

4.29%

Selling Expense

466

3.59%

Special Items

34

0.26%

Depreciation and Amortization

245

1.89%

Other

3284

25.31%

Source: US Airways Group Form 10 K

The total operating expenses of the company have increased by 2.7% from 2011 and the line item that constitutes a major part of the company's costs is the Fuel and the related costs. Fuel Costs comprise of more than 35% of the company's operating expenses and thus any increase in these costs can substantially affect the company's profitability.

Company's Fuel Consumption

Gallons Consumed (in millions)

Total Cost

Average Cost per Gallon USD

% of LCC's Operating Expense

2010

1073

2403

2.24

28.6

2011

1095

3400

3.11

35.8

2012

1102

3489

3.17

35.4

Source: US Airways Group Form 10 K

As can be seen from the table above, the company has faced a substantial increase in the cost per gallon consumed. Due to its financial problems, the company was unable to hedge against these price hikes and was directly exposed to jet fuel price fluctuations. It is stated in the Form 10 K SEC filing that the company was unable to conduct any hedging activity and that its ability to hedge in the future is limited particularly if the company's financial condition provides insufficient liquidity to meet counterparty collateral requirements.

In Millions

2012

2011

Cash, cash equivalents and investments in marketable securities

2,376

1,947

Long-term restricted cash

336

365

Total cash, cash equivalents, investments in marketable securities and

restricted cash

2,712

2,312

Source: US Airways Group Form 10 K

Although it seems that the company's overall liquidity position has improved since 2011 but given the cash requirements of the company for running its operations, through fuel costs, aircraft rentals, landing fees and other rentals and the substantial non-cancellable commitments for capital expenditure, the company is facing serious cash flow difficulty. Further, in the terms of the company's Citicorp credit facility, the company is required to maintain consolidated unrestricted cash and cash equivalents of not less than $850 million in accounts subject to control agreements. If this amount is subtracted from the above stated figures, the company only has $1,526 million of cash and cash equivalents which the company can utilize for daily running of its business. These factors and the general difficulty for the company in securing credit facility may adversely affect the company's operations in the near future.

This said, the company has been able to improve its cash flows from operations and if they are able to find some source of financing, the company might be able to continue its growth in the future.

AMR Corporation (AAMRQ.PK)

Although AMR Corporation has seen growth in revenues over the past few years, but it has been unable to translate revenue growth into profitability. Currently, under corporate reorganization, the company is seeking to improve its cost structure in order to be able to achieve sustained profits in the future.

2008

2009

2010

2011

2012

CAGR

(5-Years)

Revenues

23,766

19,917

22,170

23,979

24,855

Growth (YoY)

-16.20%

11.31%

8.16%

3.65%

1.13%

Operating Expenses

14,886

13,601

13,643

15,445

14,631

Growth (YoY)

-8.63%

0.31%

13.21%

-5.27%

-0.43%

Interest Expense

723

702

823

786

612

Growth (YoY)

-2.90%

17.24%

-4.50%

-22.14%

-4.08%

Net Income

-2,071

-1,468

-471

-1,979

-1,876

Source: Morningstar

The above table clearly shows that the company achieved a CAGR in revenues of 1.13% over the past with approximately 40% of the company's revenues generated through international operations. The company's operating and financial expenses also increased from 2008 to 2011, however since the filing of the bankruptcy in late 2011, the company has been able to reduce its operating expenses by 5.27% and its financial expenses by a remarkable 22.14%. If the company is able to cut expenses in the coming years, it would be able to transform its business and earn substantial profits.

2012

RPM

ASM

Load Factor

Cargo Ton Miles

126,406 million

152,628 million

82.80%

1,761 million

2011

RPM

ASM

Load Factor

Cargo Ton Miles

126,491 million

154,321 million

82.00%

1,783 million

Source: AMR Corporation Form 10 K

In 2012, the company has reduced its operations compared with the previous year, as indicated by the lower RPM, ASM and Cargo Ton Miles. However, the company was able to improve efficiency by increasing its load factor from 82% in 2011 to 82.8% in 2012. The company was also able to improve its passenger revenue yield per passenger mile from 14.19 cents in 2011 to 14.83 cents in 2012. Similarly a substantial improvement was also experienced in passenger revenue per available seat mile from 11.63 cents in 2011 to 12.28 cents in 2012. However the company faced a decline in its cargo revenue yield per ton mile, a fall of 1.43 cents or 3.63%.

in USD Millions

Amount

% of Total Operating Costs

Total Operating Costs

24,784

100.00%

Aircraft Fuel and Related Taxes

8,717

35.17%

Salaries and Related Costs

6,242

25.19%

Aircraft Rent

550

2.22%

Maintenance Materials and Repairs

1,133

4.57%

Other Rent and Landing Fees

1,286

5.19%

Commissions, Booking Fees and Credit Card Expense

1,050

4.24%

Food Service

535

2.16%

Depreciation and Amortization

999

4.03%

Regional Payments to AMR Eagle

1,142

4.61%

Special Items

386

1.56%

Other

2,744

11.07%

Source: AMR Corporation Form 10 K

Operating expenses for the company reduced by $343 million or approximately 1.4% from 2011. The largest component of the company's cost was its fueling and salaries and related cost. However, in its reorganization plan, the company is making large efforts in controlling its Labor cost. The company is expecting to reduce 10,500 positions across all work groups over the course of this reorganization. These changes and company's concerted efforts towards reducing its pension obligation will improve its performance significantly in the future.

AMR has also used hedging instruments in order to reduce its exposure to changes in fuel prices. Through hedging, the company was able to reduce its fuel costs by around $177 million.

In Billions

2012

2011

Unrestricted Cash and Short Term Investments

3,882

3,994

Restricted Cash and Short Term Investments

850

738

Total cash, cash equivalents, investments in marketable securities and

restricted cash

4,732

4,732

Source: AMR Corporation Form 10 K

As the company has a sound Cash position and improving Cash from operations, the company is likely to continue its hedging activities in the future, despite its financial commitments.

When the company will come out of Chapter 11 Bankruptcy, it will be much more cost efficient and it would have lesser debt. These improvements along with improving operational efficiency of the company would likely help the company in achieving better financial results than it has achieved in the recent past.

Would the Merger be Beneficial

The merger between AAMRQ and LCC was announced in February of the current year. Although the merger is still subject to approval, but if it is allowed, the transaction would be especially beneficial for US Airways. What this transaction would give LCC is greater financial stability, greater international exposure and better competitive position in the domestic aviation industry.

If the merger is approved, LCC would be able to combine with a rejuvenated business, freshly out of corporate reorganization. Recent result of AAMRQ has shown that it is improving its profitability, cash flows and debt levels. LCC would benefit greatly from incorporating with such a large organization, which has an established customer base, a stable growth in revenues and cash flows and most likely stable profitability.

Another benefit for LCC is the international exposure this transaction will bring for the company. AAMRQ, together with American Eagle carriers and the third party carriers, provides regional feed to AAMRQ, serves more than 250 cities in approximately 50 countries with on average, 3,400 daily flights. The combined network fleet is of approximately 900 aircraft. In addition to this, AAMRQ has several established marketing relationships and Joint Business Agreements with foreign carriers. Adding such a vital mix to the company's portfolio of assets would definitely bolster US Airways' profits.

In terms of domestic operations, American Airlines and US Airways would have a post merger domestic market share of approximately 21%, making it the largest domestic airline carrier in US. Since US Airways has its largest markets located on the eastern coast and AMR's largest markets located in the Southern region of the US, a combination of both companies would increase opportunities for cost savings and revenue enhancement through paired services, code sharing or through cooperation and joint operations.

All the stated benefits that this merger will bring to US Airways would most likely cause rapid growth in its revenue and profits. Once the merger is approved, I expect the share price of LCC to reach sky high. Thus, I recommend Buying LCC before you miss out on this profitable opportunity.

Source: US Airways: Paving The Way For A Sky-High Return