American Airlines Group Inc. — 2016 Second-Quarter Form 10-Q
Business context and reporting period
American Airlines Group Inc. (AAG), through American Airlines and regional carriers, operated nearly 6,700 daily flights to nearly 350 destinations in more than 50 countries. The filing covers the three and six months ended June 30, 2016, compared with the corresponding 2015 periods. Results are presented on a combined basis reflecting American and US Airways as under common control since December 9, 2013.
Key financial metrics
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Operating revenue | $10.363 billion | $10.827 billion | $19.798 billion | $20.654 billion |
| Operating income | $1.751 billion | $1.921 billion | $3.087 billion | $3.137 billion |
| Operating margin | 16.9% | 17.7% | 15.6% | 15.2% |
| Pre-tax income | $1.493 billion | $1.719 billion | $2.610 billion | $2.662 billion |
| Net income | $950 million | $1.704 billion | $1.650 billion | $2.636 billion |
| Diluted EPS | $1.68 | $2.41 | $2.80 | $3.70 |
| Operating cash flow | Not separately provided | Not separately provided | $4.833 billion | $4.841 billion |
Q2 revenue declined 4.3%, primarily because passenger yields fell 5.3%. Mainline and regional passenger revenue declined 4.4%, while cargo revenue fell 10.4%. Total passenger revenue per available seat mile declined 6.3% to 12.71 cents. Capacity increased 1.9%, while the combined passenger load factor declined 0.8 percentage points to 82.5%.
Operating expenses declined 3.3% in Q2 and 4.6% for the six-month period. Fuel expense fell 25.9% in Q2 and 29.4% year to date, benefiting from lower fuel prices. Salaries, wages and benefits increased 13.0% in Q2 and 12.4% year to date, driven by new labor contracts and employee profit sharing. Mainline CASM declined 4.6% in Q2 to 11.32 cents, but CASM excluding fuel and special items increased 4.0% to 9.12 cents.
As of June 30, 2016, AAG had $7.118 billion of unrestricted cash and short-term investments, $640 million of restricted cash and $2.425 billion of undrawn revolving capacity, or approximately $9.5 billion of total available liquidity. Management stated that it seeks to maintain at least $6.5 billion of liquidity.
Total long-term debt and capital lease obligations were $23.057 billion, including $1.715 billion of current maturities, compared with $20.807 billion at December 31, 2015. AAG reported $21.131 billion of long-term debt and capital leases net of current maturities. The 2016 credit facilities require minimum aggregate liquidity of $2.0 billion; the company reported compliance with collateral coverage tests.
Material changes versus the prior comparable period
- Revenue weakened despite capacity growth, reflecting competitive capacity expansion, lower yields, global macroeconomic softness and foreign currency weakness.
- Fuel savings were substantial, but were partly offset by higher labor costs, including $98 million of Q2 profit-sharing expense and $171 million for the first six months.
- GAAP net income declined 44.3% in Q2 and 37.4% year to date. Comparability was significantly affected by the beginning of regular income-tax expense in 2016 after the company reversed its deferred-tax valuation allowance in late 2015.
- AAG generated approximately $4.8 billion of operating cash flow in the first six months, invested $3.1 billion in capital expenditures and aircraft purchase deposits, repurchased $3.2 billion of stock and paid $119 million of dividends.
- Share count was reduced materially through repurchases. AAG repurchased 89.5 million shares during the first six months and had $1.2 billion remaining under its $9.0 billion authorization.
- Management reported 29 new mainline aircraft deliveries, 28 mainline retirements and 27 new regional aircraft additions during the first six months.
Guidance, outlook, commentary, risks and unusual items
The filing does not provide a specific earnings or revenue outlook. Management expects to retain liquidity above $6.5 billion because of leverage and continuing fleet-renewal needs. AAG had no fuel-hedging contracts outstanding and remains fully exposed to fuel-price movements; management estimated that a one-cent-per-gallon increase would raise annual fuel expense by approximately $43 million.
Q2 operating special charges were $65 million, principally merger-integration costs partly offset by bankruptcy-related credits. Mainline merger-integration expenses were $112 million in Q2 and $242 million year to date. A $36 million non-cash nonoperating charge arose from refinancing bond discounts, issuance costs, redemption premiums and fees.
AAG early adopted ASU 2016-09, recognizing $418 million of previously unrecognized excess tax benefits in deferred tax assets and retained earnings. The company recorded an effective tax rate of approximately 38% in 2016, substantially non-cash because of NOL utilization.
Key risks include revenue pressure from competition and excess capacity, fuel-price volatility, substantial leverage and fixed obligations, aircraft purchase commitments, future pension funding requirements, labor costs and disruptions, regional-carrier financial stress, technology and cybersecurity failures, foreign currency exposure, regulatory changes, airport and slot constraints, and ongoing DOJ investigations and related antitrust litigation. The filing states that the ultimate impact of these legal matters is uncertain and could be material.
AAG and American had approximately $20.0 billion of aircraft and engine purchase commitments. The company lacked financing commitments for certain aircraft deliveries through 2017 and substantially all aircraft scheduled for delivery in 2018 and later. Subsequent to quarter-end, American revised the delivery schedule for 22 Airbus A350 aircraft and announced new co-branded credit-card agreements.
Investor verification checklist
- Verify whether declining yields and PRASM stabilize or continue to offset capacity growth and fuel savings.
- Monitor CASM excluding fuel and special items, labor-cost escalation and the effect of profit-sharing and labor agreements.
- Reconcile reported liquidity with the $2.0 billion covenant minimum and management’s $6.5 billion target.
- Assess debt maturities, variable-rate exposure, aircraft financing needs and the effect of credit-rating changes.
- Evaluate the funding requirements for $20.0 billion of aircraft and engine commitments and future pension obligations.
- Track the utilization and expiration of federal and state NOLs, including potential Section 382 limitations.
- Follow the DOJ antitrust and Postal Service investigations, related lawsuits and the retiree-benefit bankruptcy proceeding.
- Review subsequent filings for developments in the revised A350 schedule, co-branded credit-card arrangements and additional EETC financing.