American Airlines Group Inc. (AAL) Earnings Call Transcript & Summary

All right. Good morning, everyone. My name is David Vernon. I am Bernstein's airline analyst and transport analyst. We are kicking off our contributions to this year's ODC with American Airlines. Vasu Raja, Chief Revenue Officer; the IR team and Vasu's predecessor and the revenue team is with us here. They're going to kick us off with a little bit of prepared remarks and then we will go into some Q&A. Just before we begin, note that on your screens, you should see a pigeonhole link for questions that you want to promote or demote and ask us to work into the conversation as well as a Procensus survey, which we can use to incorporate some real-time feedback into the event. So once again, I'd like to welcome you all. Thank you for joining us and hand it over to Vasu to kick us off with some opening remarks.

Hey. Thanks a lot. Good morning, everyone, and thanks for having me. First off, it's clear this continues to be an incredibly challenging time for our entire industry, our team and our customers. At American, we've taken actions to significantly improve our liquidity and are making decisions so we can manage through the pandemic and position our airline for when demand returns. As we look across the competitive landscape, there's no network better positioned than American's. To be clear, our network is designed for where customers want to go right now. Our hubs across the Sunbelt in Charlotte, Miami, Dallas/Fort Worth and Phoenix are best positioned to capture current customer demand. And we've seen it throughout this pandemic. In fact, in the third quarter, 1 out of every 3 passengers flying in the United States chose American. That speaks volumes to the value of American's position in the current climate. Secondly, we have the best short-haul international network, with the largest presence in Mexico and the Caribbean. Demand for this region has been strong, and based on current trends, we expect our fourth quarter revenue for this region to remain strong, achieving as much as 70% of 2019 levels. Third, we're taking this opportunity to be creative and take a fresh look at future opportunities. We're finding smart ways to strengthen our hubs in key markets. The future of aviation must include strong partnerships and American leads in this regard. Whether it's our recently announced partnerships with Alaska and JetBlue, our equity investment in China Southern or our joint business agreements with leading airlines like IAG, JAL and Qantas, we are raising the competitive bar and providing customers with better choices and a world-class product. In addition to being nimble when it comes to our network, we've continued to enhance the customer experience. Recently, we've removed change fees from most of our flying, eliminated fees on award tickets and extended mileage validity. We've created partnerships to establish preflight testing programs so customers are more able to easily visit destinations like Hawaii and the Caribbean. Our clean commitment is industry-leading and multiple studies show it's extremely safe to fly in the era of COVID-19. I've been very -- I've been flying multiple times every week and I see it, a level of cleaning, the safety measures and the diligence from our team and customers is truly incredible. Most importantly, in the face of unprecedented adversity and uncertainty, the American team is doing amazing work to take care of our customers and each other. We are tremendously proud of what they continue to do each and every day. In closing, we remain in an uncertain demand environment, so we are focused on being flexible and nimble in all parts of our organization. And we are committed to making sure our customers feel safe and comfortable and have flexibility when they travel. We know we still have a long road ahead of us, but our entire team remains fully engaged and focused on not just getting through this pandemic but making sure we are prepared for when demand returns. With that, I'm happy to take any questions you might have. And again, thanks for having us.

Yes, absolutely. Obviously, a ton of questions here. We are kind of flying through the unknown territory towards a destination that could be unfamiliar in terms of what the industry is going to look like in 2, 3, 5 years, whatever the recovery is going to take. One area that I want to kind of start with is the level of earnings power that American should have coming out of the crisis. There's obviously the recovery, the leverage to getting to wherever the new world is going to be. But if we were to think about looking at American's earnings power, if you go back to 2019, you were several hundred basis points below peers on a margin level. Why isn't that 2019 benchmark the right way to think about your operating performance and future earnings power coming out of the pandemic?

That's an excellent question, and there's probably a couple of reasons for it. First are reasons that were unique and idiosyncratic to us in 2019. The second are some of the more fundamental or structural changes that we're able to bring about through this pandemic. To that, to elaborate on it, in 2019, for us, there were a number of really unique and unprecedented challenges, the first and foremost of which is that we were in a strange place operationally, primarily with where we were with our TWU and IAM. And that created a real overhang on how we performed. And unsurprisingly, when you don't perform well operationally, that creates a real drag on your airline, not just in your unit cost production but also in the very simple reason for whether or not customers want to go and fly on you. And so that was a real overhang for us in 2019, one which is well behind us. But we will prove that on the other end of this. The other thing, too, are situations like the MAX created a really unique situation for us in 2019, which is, again, not repeatable in the world of the future. But bigger than that are things that we can control are using this pandemic to reset very mildly. I've discussed this on a number of our calls but as we look back over the last several years, really the airline's RASM performance relative to our competition has grown in our strongest hubs. And the more we've grown in those strong hubs such as Dallas/Fort Worth or Charlotte, the more that has grown. The places in our system which are more marginal are places like the Northeast and the West Coast where we simply lacked the network to be able to compete and provide a legitimate alternative to our larger network competitors there. In those places, our RASM has lagged. And through this crisis, through partnerships that we were starting to build before it but whose commercial appeal, we will accelerate through the crisis, we anticipate that more of our system will be able to produce a higher level of RASM. Additionally, as we bring back the airline, we're going to bring back an airline that's much more efficient than the one that was there before. And so the combined effect of being a more CASM-efficient airline and a more RASM-productive airline is something where we believe we can earn a lot more in a steady state. And when we get to a steady state is an open and valid question, but we certainly have great confidence that, that will happen for a number of reasons.

All right. So there's a lot in that answer so I want to try to unbundle it a little bit because I do think this is kind of central to the controversy on the stock in terms of your ability to grow into the balance sheet and things like that. When you look back at the onetimers in 2019 and just thinking about the impact that the MAX had, the impact that the labor slowdown had, is there a way to quantify that, whether it's in margin or dollar terms that would say, if we were -- if American was here, they should have been here if those 2 onetime items wouldn't have been there in the 2019 performance? Has there been any -- I can't imagine there's been a ton of spare time down there to go do post-op on 2019. But is there a way to even directionally kind of think about that?

Yes. No, you're absolutely right. There hasn't been a ton of time to do post-op on 2019. And we're critically -- for a lot of reasons, we haven't chosen to do post-op on 2019 because we see this crisis as a real opportunity to reset our trajectory, right? A chance to go and consolidate a lot of decisions, which would have been risky or difficult at a time when the airline -- though it might have been under-earning its competitors, was still out-earning 80 or 85 years of its history. But now in a world where there isn't revenue to speak of, we can go and try things and take actions that would have been riskier before. So we spend a lot less time doing a post-op on 2019, a lot more time trying to reset for the future. And so the way I would certainly encourage you and others to think about this is even if you take away some of the idiosyncratic things, we believe that this is an airline that should produce RASM at greater than 100% of the industry, which is not something that we've consistently done but could also produce it on a more effective unit cost basis than what we did in 2019. And so if you just assume those 2 things that we're able to produce more RASM and produce it, if we have the same capacity production as 2019 but could do it with 95-or-so percent of the CASM production and 105% of the RASM production, that starts becoming a very different airline than what was there before. And how we go about parsing that into what was the MAX than what are future changes is something that we haven't done just because there's not a lot of upside to it for us. The practical thing is how do we build an airline that can really fulfill its earnings potential.

Okay. And I guess the second thing you called out was this notion of sort of revenue mix, the revenue premium that you're earning in your hubs versus some of the areas where you've been less -- have less of a network. Is this going to be -- is this shift going to happen because of improvement in the hubs or the change in approach towards the West Coast and East Coast kind of opportunities through the codeshare arrangements with JetBlue and Alaska?

An excellent question, the answer is both. And here's how that, in our hubs such as Dallas/Fort Worth, we still have the capacity to grow larger in Dallas/Fort Worth on 2 levels: one, by adding more flights and two, by adding flights with larger-gauge airplanes. There's larger-gauge airplanes in a hub as big as Dallas/Fort Worth, we find both produce -- they produce high marginal profitability because the RASM of that is oftentimes 100% of the existing flying, but the unit cost of that can be 90% of the existing flying, potentially even lower depending on how we performed the upgauge. Similarly in Charlotte, we have the ability to grow it primarily by upgauging it. And we have that same capacity through our system, DCA, Chicago, Phoenix, Philadelphia, you name it. And so one important part is that those places where we are, as we call it, organically strong, we need to continue to build upon the strengths there and orient more and more of the organic base of the airline around those places where we can grow in a CASM-efficient and RASM-productive manner. The thing with American Airlines, I just really can't say it enough, is the parts of our system which have really lagged the industry are not the ones that people often think of. I think that there's -- sometimes, it's feeling that hubs such as Phoenix or Philadelphia or something like that is where American underperforms. That couldn't be further from the truth. Indeed, even as we grew in markets like Dallas/Fort Worth, we saw our RASM growth grow in Phoenix. The places where American tends to lag the industry are unsurprisingly places where our network is weaker than our largest competitors, which are the West Coast and the Northeast. And those are places where there's such a massive base of business travel and managed corporate traffic that American Airlines has really struggled to compete for. And when we've been able to win it, we won it by sometimes discounting our very best products such as the JFK, LA Transcon product or the Heathrow product much more than what our competitors have. And so a big part of our partnerships and our approach to it is very different than the traditional codeshares of the past. But our approach to this is to make partnerships both with Alaska and JetBlue so the customer would willingly choose our synthetic network over another airline's organic network. But what that very importantly does for our P&L is that instead of going and trying to fund network projects which don't work, we can devote more of our resources to those which can. So in New York City, in LaGuardia today, we operate a number of -- a big chunk of our asset base is flown on 50-seat regional jets. Well, that's probably the most inefficient platform for a market like New York City with all of the costs associated with it, but also for the kind of customer that wants to fly on it. We did it primarily the size New York to the demand that we had going into it. But now with our partnership there, we see an opportunity where we can move the 50-seat regional jets out between AA and JetBlue, bring more bigger jets into LaGuardia and then ultimately have the AA brand go and fly more long-haul international, which has been actually the thing in New York that's really worked the best for us. So in doing that, we really become -- without going and deploying more capital or indeed, with being a lot more prudent in how we deploy the capital that we've got, we can go produce a lot more revenue out of those markets than what we've had and create a much better proposition for the customers than what they have today.

And then how -- so specifically on this topic, how different are these from a traditional kind of codeshare? And how do you feel about the ability to kind of really leverage that synthetic network in a corporate sale environment versus an organic network or a fully in-sourced network from some of your peers? Like how is that selling proposition going to be different?

More excellent questions. We feel quite confident actually about selling proposition that already our West Coast network with Alaska is increasingly successful in winning corporate business. And it certainly has a high degree of interest from corporations up and down the West and East Coast who now suddenly have a legitimate third alternative. And for us, there's 2 parts to it, to your first question, right, historically, the way airlines have operated codeshares, while it's -- those things started at a time when airlines used it as primarily a network extension. But I fly into your hub and I get connections beyond it, you fly into my hub and you get connections beyond it. And it was a cheap way to go and fabricate a larger network. And there's some real value in that. But what the airline has never finished all the way out is to make it where, for a customer, it's a really seamless proposition. And in order to go and make it where we can legitimately win business customers and higher-value leisure customers, we have to make that happen. And so what makes these things very different for us is it's not -- we have all of the traditional economics of codesharing, but both us and our partners are really incentivized based on ongoing and winning incremental customers away from -- especially incremental corporate customers away from the other larger airline networks. And when we can, that's -- the more of that we're able to do, the more us and our partners benefit. And so you'll see a lot more rolling out in the next several weeks that make this less abstract and a lot more concrete. But we envision things where there's a more seamless loyalty proposition where -- and you can do things like if you're a member of one frequent flyer base or the other, you can get upgraded on the other one's metal that your benefits apply, your corporate discount applies. There's so many things which were at best clunky in the old days of codesharing or things that we need to go and rectify. Now I'll tell you like we're -- we completely recognize that it's a more unconventional approach to it. But the reality is, as we look at our network, the places that are underperforming are places where, as I described it before, where on a structural basis, we are -- they're too important to quit and we're too small to win. But that's not a satisfying answer, like that can't be an excuse the airline uses. So we have to find a different way to go and make the West Coast and New York successful, and we will do so. And time will tell and the proof will be in the results.

And as you think about kind of that road map of kind of differentiating that experience, making the rewards programs and the loyalty programs a little bit more interchangeable, how much more runway is there from what's implemented today to what's implemented in the future? I'd always kind of been thinking kind of coming into this, Doug had talked about this quite about in a couple of different conversations, where a lot of the IT projects that you guys had wanted to do to manage up some of your yields and catch up and close some of that revenue gap had been delayed a little bit because of the prior integration work. Is there additional work that then still needs to be added to that queue of projects around some of the codeshare stuff? Or how should we think about that?

Yes. Look, there is additional work to be done. But as we like to say it, that's our problem, not the customer's problem. That we must go and be able to deliver it because the value to the customer is so huge. And there are so many cities where American Airlines is the strongest carrier in the spoke. The one thing that American Airlines isn't able to do on its own is get you nonstop to a number of cities in the West Coast and very often, the cities in the Northeast. And with our partnerships, we can now go and do that. But the only way that becomes really salient to you as a customer is if your frequent flyer benefits as an Executive Platinum on American Airlines can extend in some way to these other carriers. And that's a meaningful thing which we've never done. We have infinite amounts of progress there. But now we believe there's a way to do it. And things like technology are indeed a barrier but they're not an excuse. But being able to do it is fulfilling a massive part of our customer offering, which therefore -- and translates very directly into our financial performance.

Okay. And then the last category of stuff that you'd kind of pointed out to would be the efficiency side. If you think about the earnings power being better in the future, coming back to the original points around the revenue mix, the onetime effects of the MAX and everything else and then this notion of coming out more efficiently. If you could just help us think from a top-down standpoint, obviously, there's a fleet component of that, if you could talk to that. And then also some of the fixed costs. Like how much of the cost reduction that you guys have had to go through, which is painful, how much of that is permanent versus a temporary sort of band-aid? Or how do you think about the fixed cost structure that you're going to need going forward?

Yes. That's an excellent question, too. And we believe that there's a number of ways where, one, there's fixed costs that we have been able to, through this, go and get out of. And then there's other fixed costs which we can go and scale a lot better across our system and I'll speak to both. To the first, right, we have shaved the number of fleet types in this airline down meaningfully. And for a long time, we had debated taking out the 190 or even different fleet transactions involving the A330 fleet. And in the times predating the crisis, there was never really good ways to do it. Either our alternative airplane solutions weren't that great or the kind of operational damage it would take to go and do a fleet transition of 20 or 30 airplanes, it didn't really pay. Well, now when there's no demand, we just accelerated a lot of those things indeed. When back in March or April, there's probably no airline more aggressive than American globally in going and making those decisions. So we made them pretty fast and frankly, quite ruthlessly. And by doing that, that takes a massive amount of fixed costs out of the airline that -- on a number of levels, right? One, of course, with things like the 190s or the 330s, we no longer have to go and carry the airplane, the parts, things like that. As the airline goes and scales up, we don't need to train people through small fleet types, which creates a lot of efficiency in our training process and our pilot deployment. But what it also does is it creates a meaningful amount of efficiency in how we schedule the airline. Because we had A330s that could only go out of Philadelphia and Charlotte, we were carrying as many as 2 to 3 incremental wide-body spares. So if you think about it, we were deploying $300-ish million worth of capital to produce revenue. Now we can produce that exact same amount of revenue without deploying that $300 million worth of capital and all the OpEx that goes with it because we can take the 777 and 787 platforms and spread it across the whole system. We can be a lot more creative in how we go and support the airline network that we have. So you look at those things and there's material changes that fleet simplification brings about for us. And that happens right now. It will, of course, be a lot more evident when the airline is operating at scale, but that's something which is meaningful as cost doesn't come back. But also through this, there's opportunity to go and scale the cost that we have. We had long been in a process of harmonizing our different fleet types. And by doing that, part of what we get is we'll take A321s that used to have 165, 170 seats and operate them really in its manufacturer design configuration, the way our competitors do with something like 190 seats on it. Doing things like that, again, it just -- it helps scale out the cost base of the airline. When we go and take more -- we'll upgauge at a 50-seat regional jets and the bigger regional jets and operate those in markets such as DCA, New York, Chicago. And whenever we do that, we take the big fixed expenses of operating in these relatively expensive cities, and we scale them out over a much more efficient aircraft platforms where, frankly, we can generate more revenues than what we could offer the 50-seat jet. So there's really 2 parts to it. It's -- we'll be taking out fixed expenses and also scaling the fixed expenses we've got more efficiently.

Okay. And as you think about the crisis creating an opportunity to accelerate some of your fleet changes and really kind of push forward to the new operating platform, smaller, simpler set of operating platforms, has there been any other opportunities to accelerate change inside of American that's been created as a result of some of the lower workload? Have you been pushing forward on facilities investments, things like that? Or like I'm just trying to get a sense for maybe some other areas that you've been able to take advantage of the crisis. And then the second part of that would be areas that you've had to push off, right? Are you -- have you seen any sort of delays in some areas?

Yes. Dave, this may be a relatively unconventional answer to your question but I think it's probably the most meaningful in some ways. Probably the -- one of the biggest changes isn't actually how we go about working and making decisions that -- through this, not only at the very beginning were we very aggressive in taking out fleet types, we're also very, very aggressive in taking out management overhead, too, that we were taking out 30%, 40% of some of the senior-most positions in the company. And what that does, it's made us a lot leaner. And as we have become leaner, we've also been a lot faster to market that we make decisions fast, we move on. As we like to say around here, though it's woefully painful being an airline that's earning revenues at 25% to 30% of what it did in 2019, the reality is that the marginal risk of any given revenue decision is very small. And so we're willing to go and try things and take chances. And if that means in some cases, the schedule will be bigger than others. In other cases, we've been smaller than others. When we got rid of change fees, we did it in such a way where as things go out, go forward, it's going to be a much easier customer message for people. And so there's a number of things where just the speed at which we make decisions and our ability to try things and move on has accelerated. And so to your point, yes, we've been a lot more focused on what really matters and building an airline, we're coming out of this thing that we are able to fulfill our potential and really outperform financially, outperform culturally, too, and we get there by being efficient in how we decide things and being really ruthless in how we prioritize things across the airline. So that's probably been the biggest thing. And that -- from that, that's led to a number of other changes, whether it's a clear IT prioritization across the revenue groups and the operational groups or consistent goals across a number of different organizations. Fewer times to do the same analysis, just measure once and cut. There's a number of things that we can go point at, but the bigger thing is probably more of a cultural or organizational change in how we think about the problem.

And as you think about kind of the portfolio of revenue initiatives that you might have wanted to be managing now in a world where there wasn't COVID versus where we're going to be coming out of it, what does that pipeline look like? What do you need to be able to do on whether it's a technology basis or a marketing basis to kind of help close that unit revenue gap that you talked about earlier? Like I'm just trying to get a sense if you could kind of -- if you could just lay out for us like what are going to be the imperatives on the revenue management side as demand starts to recover? Obviously, filling seats is going to help us, it's a rising tide lifting all boats, all that kind of stuff. But as you think about the critical things that you need to do, can you talk to kind of what they are and give us a sense for how long it's going to take to kind of deliver them?

Absolutely. Look -- and they're pretty simple for us in many ways. The first and foremost is with our network, play to our strengths. The things that we do well, we do really, really well. And indeed, the pandemic has provided strangely a level of positive reinforcement to that. And we see it now that -- in Dallas/Fort Worth and Charlotte and Phoenix, the larger those things are, the more naturally the airline can at least outperform versus its competitors but also the more diversified its revenue stream is. We can be big for business. We can shift those hubs to be big for leisure. We have a lot of flexibility there. So the first part is to play to our strength and be big where we can win organically. The second part is, as we've talked a lot about, is really make our partnerships very seamless and very effective. We've talked about that with -- primarily in regards to our recent partnership with JetBlue and Alaska, but it applies furthermore to our partnerships with our long-standing JV carriers but also with our credit card partners such as Citi and Barclays, where we still believe there's a lot of upside that we haven't yet tapped, especially at a time when credit card spending is not falling nearly as much as airline spending is. The next big category are really making -- is making the airline easy to do business with. And that sounds like a strange thing for those who've been around the world of airline revenue management for a long time because probably -- in no company has there been such, in some cases, byzantine pricing and customer policies. But in a world where there's simply not enough customers or demand, which by the way, is a problem that the airlines have never had to do any other crisis, it's imperative that we are easy to do business with and that we are really dynamic in how we think about our customers because so many of the things that we've clung to historically driven YM forecast, certain attributes of the network that impacts competitive pricing are really going to start to change. And our true north needs to be in making ourselves easy to do business with -- easy for our customers to do business with for the simple reason that if you are, they're more likely to fly you more and pay you more. So none of that stuff is really rocket science. And indeed, the simplicity of it is actually its beauty. We know exactly what we need to do to go and execute. And we need to do it fast. But the last thing I'll say, David, is airlines, as we've come to see them are, in many ways, momentum gains, right? There -- whether it's scheduling or pricing or running an airport operation, there's tens of thousands of people making hundreds of thousands of small decisions at a time. And though this crisis is brutal and taxing and all of those things, it also gives us an opportunity to reset the decision compass of how we run this airline. And when we have a few simple priorities that everyone can go get behind that makes sense, it makes it easy to go and have a lot of people make a lot of good decisions and good decisions feed on good decisions. And that's how airlines end up improving and outperforming. So we have a clear idea for what we need to do, who we need to be and how we need to get there. And now it's just a matter of delivering.

And as you think about that what we need to see kind of happen to get to that point of cash flow breakeven and then start to deleverage and then unlock some of the equity upside potential that at least we continue to see in the business, what are those imperatives that have to happen? Is it a recovery of hub traffic? Is it a recovery of international traffic? Is it a return of business travel? Can you give us a sense for what you need to see to feel confident that you are going to get to that point of breakeven and ability to start repairing the balance sheet?