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Vaughn Cordle, CFA

 
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  • Is Bankruptcy The Best Solution For AMR? [View article]
    IF Amr files bankruptcy the PBGC steps in and forces an "involuntary" termination and takes over the plan assets and obligations. As of the last reporting period (Dec 2010) the plans had $12.9 billion in obligations and $7.7 billion in assets. $5.5 billion in under-funding.

    The under-funding is much worse than reported because the company must use a lower discount rate ( results in a higher present value of liabilities) and a lower return on assets. This will occur at the end of this year.

    If the company files, the under-funding will get worse because the company no longer puts $500-$600 million in the plans per year and the plan assets no longer can invest in riskier (higher return) equity assets.

    When we ran the numbers on United and US Airways - a year before their BK filings, we estimated that the plans would end up around 40% funded, not the 80-90% that the pilots thought.

    The company has a negative net (book) equity of $6.8 billion, and the adjusted under-funding amount is not yet reported on the balance sheet. If the company files BK, the equity held by share holders is wiped out because there no tangible equity.

    Stated differently, the shareholders get nothing and the creditors (including labor) must accept a major haircut if the company is to emerge from BK. The creditors become the new shareholders post-BK. The company will emerge from BK because it has a valuable franchise once debt and costs are brought down to levels the market can support.
    Oct 29 12:30 AM | Likes Like |Link to Comment
  • American-US Air Merger Would Bolster The Industry [View article]
    Have you considered the following:

    Given the $16 billion in AA employee pension and health care obligations, it should be more than obvious that employees have a [negotiated] claim that cannot be honored by AA and the owners of the assets in its current form. The unfunded part of the employee's claims are around $8.5 billion, which is 10x the market value of the company's equity - the value of the shareholders' claim.

    Why should shareholders support a company that has a negative $29 [book] value (when unfunded obligations are properly added to the balance sheet) per share?

    Many AA employees blames a focus on the "almighty dollar" as a reason for our country's and AA's downfall yet don't appear to see the link between the employees' unsustainable claim on a business that has lost over $12 billion over the last decade. AA stock is down 85% over the last 5 years. AA is not a viable business if it's not fit for investment.
    Oct 28 05:19 PM | Likes Like |Link to Comment
  • American-US Air Merger Would Bolster The Industry [View article]
    Eliminate a competitor, or reduce the intensity of rivalry, and pricing firms up. The alternative could be worse and it's the relative outcome that matters, even if the deal does not appear to be a winner.

    Stated differently, the merger strategy may lose LESS money than the status quo scenario. Hence it's the best option for management and the company's stakeholders.
    Oct 28 05:07 PM | Likes Like |Link to Comment
  • Is Bankruptcy The Best Solution For AMR? [View article]
    Liquidity becomes a real problem next year if GDP growth comes in at the low range of the estimates and fuel prices stay in the $3 per gal range. Given current CAPEX and maturing debt projections, cash levels will be low enough to force the company to seek protection. The borrowing capacity of the company is now very limited. Moreover, the company will have to update the discount rate and actual plan returns on its defined benefit pension and health care plans at the end of the year.

    I've updated the pension accounting with the current discount rate and actual returns. Required cash contributions will increase in 2012 because of these two changes, which in turn will reduce earnings, cash, and result in a much larger negative net worth. Hence the belief that AMR is likely to file BK sometime in 2012. Large increases in labor costs could also trigger the filing.

    There is the chance that GDP, fuel, discount rates, actual plan returns could be significantly better than estimated, but this only puts off the day of reckoning in my views. The company's strategy of new aircraft and spinning off Eagle is a day late and a dollar short.

    This website is for investors and the perspective of the discussion of AMR is for investors, not employees per say. Employee feedback welcome because it helps both parties understand the different perspectives.

    Management, in theory at least, works for the owners of the assets - the shareholders. The idea is to maximizing firm value, which includes the market value of debt. Labor is on the opposite side of the same investment coin as capital and analysts are focused on determining the intrinsic value of the business based on future cash flow.

    It's easy to understand why employees would think that a security analyst's view is unsympathetic. However, facts are facts and every CEO must manage the business to maximize firm value. This requires satisfying all stakeholders to a certain and sufficient degree.

    When an airline is old it accumulates a lot of legacy debt and costs and it becomes very difficult to compete with younger and lower cost competitors. AMR is very old and it never shed its legacy baggage in a BK like US Airways, Continental, United, Delta, and Northwest.

    One of the biggest problems AMR has is its $16 billion in pension and health care obligations, which will get much worse as it updates accounting at the end of the year. This negative impact has yet to show up in the consensus earnings estimates.

    Our study on sell side research recommendations, and actual returns versus estimates, examined 16 analysts over 10 years. Conclusion: The consensus earnings estimates - driven mostly by sell side analysts - is always too optimistic and represents a major lagging indicator. Great fundamental research, but not too good in terms of helping investors making money.
    Oct 25 09:11 AM | 1 Like Like |Link to Comment
  • Is Bankruptcy The Best Solution For AMR? [View article]
    AMR management does appears to be using the bankruptcy scare as a backdrop to labor contract negotiations. Analysts are discussing the potential for bankruptcy because of liquidity concerns.

    If the company ultimately files for BK protection and emerges, its credit worthiness and ability to secure new aircraft improves. However, the airline will likely continue to be one of the weakest competitors. Hence the business case for a merger post-BK.

    If AMR avoids bankruptcy, it will continue to muddle along and destroy ecomomic value (ROIC-WACC).
    Oct 21 03:08 PM | 1 Like Like |Link to Comment
  • Is Bankruptcy The Best Solution For AMR? [View article]
    Feel free to jump in anytime to discuss the "big picture" that may invalidate the statistics and numbers presented.

    It has been my experience that folks that throw that quote around either (1) don't understand the numbers under discussion, or (2) attempt to diminish someone else's opinion or view.

    I do agree that too often data crunchers miss the forest for the trees. However, if you are going to throw that quote out there in response to a post, you should back it up with your own numbers to make whatever case you want to make. This is the value of argumentation, it forces both parties to support their argument with facts and evidence.

    I've made an argument and supported it. Make yours and lets flesh out what the big picture is and how it relates to the numbers and statistics.
    Oct 20 05:13 PM | Likes Like |Link to Comment
  • Is Bankruptcy The Best Solution For AMR? [View article]
    If AMR files BK the creditors - including the pilots and other employees - will negotiate an equity stake in the new airline. Management will have exclusive rights to present a turnaround plan to the court, but only for a limited period of time. Typically ,and this happened at the other airlines that emerged from BK, there is a management shakeup and the company can clean out the deadwood. The threat is a brain-drain of the most valuable executives that will have little incentive to hang around.

    The current CEO/CFO and senior team may be able to retain power (or they may bail before BK), but only if their plan is accepted by the newly structured Board and BK court. The Board will have to provide enough incentive for the key executives to stay at a bankrupt company where restricted shares and options have no value. Hence it's likely that the management team that survives will get 3-6% of the new company. This is typical and would be worth several hundred million for the management team. Pilots and other employees can also negotiate some percentage of equity. Recall that the DAL pilots got about 6%, if memory serves, of the new airline that emerged from BK and the merger. A great deal for the pilots, if they were smart enough to sell before the most recent decline.

    One scenario has AMR filing for bankruptcy. It's based on a below-trend GDP growth rate and jet fuel prices around $3/gallon. At the end of the year the company will have to update its discount rate (lower) and plan returns (lower) for the pension plans. This will result in higher cash outlays, lower earnings, and a much larger negative net worth in 2012.

    Another scenario is one where AMR is able to survive a very weak 2012 and tweak up the operations in a way that results adequate cash flow and liquidity by 2013 or 2014. At that point, hopefully, the economy is back up to 3% or so from 1.4% this year and around 1.8% next. A BK is a toss up for next year and industry fundamentals could improve before AMR's cash balance becomes too low.
    Oct 20 04:39 PM | Likes Like |Link to Comment
  • Is Bankruptcy The Best Solution For AMR? [View article]
    I fully understand why employees are disgruntled, and they should be. It could be said that concessions in 2003 - required after the impact of 911 - covered much of the higher fuel costs that started to soar during the 2004-2008 period.

    The recession of 2008-2009 killed revenue and earnings and fuel costs are 31% higher this year than last. Higher costs of too much debt, and pension/health care obligations drive higher-than-competition costs. Hence "savings" from concessions simply covered higher costs and losses. FYI, AMR's net debt (includes cash) estimate will be $3.3 billion higher next year than 2010's. This means the cost of capital increases.

    Higher jet fuel costs and a severe recessions drove revenue down and costs up. Add to that even more debt to cover the losses and it adds up to a company that can't earn its cost of capital.
    Oct 20 12:05 PM | Likes Like |Link to Comment
  • Is Bankruptcy The Best Solution For AMR? [View article]
    Demonizing management and those that point out cost problems may make one feel better, but doesn't help clarify the issues or solve the competitive problems. This takes an un-emotional analysis that is strategic and holistic in nature, and one that considers the required return on capital.

    I've always found that those that don't trust the numbers, don't understand the numbers. And those that don't like the numbers typically bash (or smear) those that present an analysis that doesn't match up with their world view. A real shame.
    Oct 20 08:56 AM | 1 Like Like |Link to Comment
  • Is Bankruptcy The Best Solution For AMR? [View article]
    Data provided are actual data from DOT form 41. No accounting problems here. Many employees tend to confuse hourly wages with block hour costs, which include productivity. And, health care and pension costs must be considered when comparing apples-to-apples labor costs.

    I too took a major hit from UAL's bankruptcy so I'm keenly aware of the the pain that most airline employees have endured. You wrongly assume that I "play with their team" when I write about the industry. The analyses is data driven and is presented from the shareholders' perspective. This is a vaild prespective and one that pilots and other employees should consider when they think about the industry and their airlines.

    Typically, the employees' perspective is one of "them against us". This is a shame because it does not allow an objective understanding of the industry fundamentals and comnpany specfic economics that drive earnings and ablity to pay employees what they deem is fair.
    Oct 20 08:23 AM | 1 Like Like |Link to Comment
  • Is Bankruptcy The Best Solution For AMR? [View article]
    Thanks for the very insightful feedback on AMR's high cost maintenance facilities and people. I have not seen any in-depth analysis on this topic. We have examined unit maintenance costs per fleet type. It's clear that AMR has a major disadvantage with key competitors, especially low-cost domestic airlines that have younger employees and no defined benefit plans with heavy health care costs.

    I have pointed out, in various forums and research notes, that the 4 network airlines reduced mainline (domestic-only) aircraft by 1000 or 31% over the last decade. Current domestic market share is about 65%, which is down from 90% 20 years ago. The lower the market share, the lower the pricing power. They have increased the number of commuter operations - 1,300 increase in aircraft over the same decade - that use much lower labor costs. This strategy is defensive as they attempt to fend off lower cost (and fare) competitors like Southwest and Jetblue from gaining market share in fortress hubs. It's basically a labor arbitrage that has resulted in LESS market share loss than what would have occurred otherwise. Unfortunately, it has reduced the number of mainline employees at the network airlines. A real shame given that it boils down to the cost of a young workforce versus a older workforce with lots of retirees to support. A real dilemma for labor leaders who attempt to maintain compensation levels and headcount.

    Average block labor costs at the 21 commuter airlines is under $600 versus $2564 at the networks and $1224 at the (7) low cost airlines. Southwest is now the highest labor cost airline in the low-cost airline segment.
    Oct 20 08:02 AM | 2 Likes Like |Link to Comment
  • Is Bankruptcy The Best Solution For AMR? [View article]
    Apples-to-apples comparisons are made by examining each of the regions and fleet types separately. Most only compare system-wide data and this, as you rightly suggest, can be misleading. I post system-wide data because it can be more easily verified. The domestic-only data is more interesting and paints an even worse fare/cost disadvantage for AMR when examined relative to competitors like Southwest,.

    You are also right that maintenance costs are much lower at Southwest. Obviously, older aircraft have higher maintenance and fuel costs. Example: AMR's old MD 80 fleet has a 35% fuel cost disadvantage with the newer B737-800 replacement models. However, this doesn't tell the whole story.

    Higher productivity of Southwest's fleet reduces its relative unit [aircraft[ cost as does higher reliability and lower maintenance costs. In other words, AMR's 20+ year old MD 80 series is more expensive to operate than the fuel-only cost advantage implies.
    Oct 20 07:16 AM | 1 Like Like |Link to Comment
  • Is Bankruptcy The Best Solution For AMR? [View article]
    Perhaps if you dig a little deeper you would discover that:

    AMR's benefit/pension costs per block hour are $794, which is $414 higher than Southwest's $380. If AMR had Southwest's lower pension/health costs its earnings would $894 million a year higher - all else held constant. Compare that number to last year's reported earnings and the cost problem should be more than obvious.

    Southwest's wages per pilot and flight attendant are on average higher than AMR's, but unit labor costs at AMR are much higher.

    Southwest's block hour wages (only wages) are 70% of AMR's and pension/health care costs are 48% of AMR's. Why is this the case? Southwest's employees are more productive and have a lower weighted average seniority. Both of these advantages results in total labor [block hour] costs that are 36% lower than AMR's.

    Bottom line: If AMR had Southwest's labor cost, its costs would be $2.3 billion a year lower. The age of the airline and its hub-and-spoke model gets to the heart of the competitive cost problem.

    Current management came aboard after these problems were established. It's a structural problem that can't be solved without a restructuring of the airline, which includes its commuter unit.
    Oct 20 07:11 AM | 1 Like Like |Link to Comment
  • Is Bankruptcy The Best Solution For AMR? [View article]
    The weak link is too much debt and obligations on the balance sheet, which in turn drives higher operating costs.

    Even the best CEO in the world cannot produce a profit given AMR's set of cost and liability disadvantages. Throw in a disgruntled workforce that wants big pay raises...

    It's not labors' fault the company is in such bad shape even as AMR's pension and healthcare obligations are key reasons the company is in trouble. The industry's composition has changed as lower-cost airlines have gained greater market share.

    AMR is a price-taker and the price it can command is below the cost of capital. Hence the long term solution is to reduce capital. This may not be possible outside of bankruptcy.
    Oct 20 06:19 AM | 1 Like Like |Link to Comment
  • Is Bankruptcy The Best Solution For AMR? [View article]
    AMR has underinvested in competitive resources for too many years, hence the 15 year old fleet. Hard to invest in improving customer service when the company has lost over $12 billion in the last ten years and will lose another $1 billion over the next 12 months.
    Oct 20 06:06 AM | 1 Like Like |Link to Comment
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