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

Good morning, everyone, and welcome to Bernstein's 40th Annual Strategic Decisions Conference. My name is David Vernon. I'm the senior analyst covering transports and airlines for Bernstein. Joining me today is Robert Isom [indiscernible] Airlines and [ Devon Scott ] along the IR team here with us. We are going to be taking some questions to the [indiscernible] applications, if you have anything you want to put into the conversations, go ahead and put it there and we'll see if we can work that into the Q&A. We're going to start off with some prepared remarks with Robert and then get into some of the issues. So I actually, we're going to start off with Scott Long who's going to give us some forward-looking disclaimers, and then we'll kick it off.

Perfect. Thank you Dave. Good morning, everyone. I just want to remind everyone that the [indiscernible] this morning contains forward-looking statements that represent our expectations of future events. Numerous risks and uncertainties could cause actual results to differ materially from these projections. Information about some of these risks and uncertainties is included in our SEC filings and the information we're sharing today is as of today's date. We have no obligation to update [indiscernible]. Thanks.

So thank you for that, Scott. So Robert, I know you've got some prepared remarks on the preannouncement last night. So I'm going to let you open it up, and we'll start from there.

Thanks, David. And I appreciate the chance to be here. The news we delivered last night, look, I'm disappointed in our results. I'm not pleased. And so I might just like to start off with this. American is focused on delivering on our long-term objectives that we laid out at our Investor Day. Our operational reliability continues to perform at historically strong levels and among the very best in the industry. Our fleet is the best among the U.S. network carriers, the youngest and most simplified and it drives enormous value to the airline. This fleet puts us in a position where our CapEx is stable and very moderate through the end of the decade. This low relative CapEx has allowed us to make great progress in reducing our total debt and repairing our balance sheet. We're on track to hit our target of reducing total debt by $15 billion by the end of 2025. Our network is well positioned, and we're renegotiating our co-branded credit card relationships. We're reengineering our business to operate as efficiently and productively as possible, and I believe that we are managing our cost as best as well as anyone in the business. All of this positions us very well, and we're focused on delivering on our stated objectives of producing free cash flow, strengthening our balance sheet and improving margins. Also, we're seeing a number of positives in the business that are worth noting, which contributes to our confidence in the long term. Premium demand is stronger across all entities, premium cabin revenue for the year -- our year-to-date is up 20% or 10%, is up 10% year-over-year and in line with capacity growth. Long-haul international markets are performing well. We've seen significant improvements in regional pilot trends that are allowing us to return 50 more regional aircraft into our network in the second half of the year. And our ancillary revenues are up to. In the first quarter of 2024, ancillary revenue was up 20% year-on-year and second quarter is tracking similarly. That said, we adjusted our guidance today. And as I said, I'm disappointed in that. We now expect second quarter operating margin -- our second quarter operating margin will be 1 percentage point lower than we originally anticipated. This adjustment is largely due to a softer domestic revenue environment that we are expecting and our performance within that environment, partially offset by lower fuel and ex- fuel cost performance. Taking a look at our revenue production. Our expectation for domestic performance has worsened materially since we provided guidance in April for a few reasons. First, we're seeing softness in customer bookings relative to our expectations that we believe is in part due to the changes that we have made to our sales and distribution strategy. To address this, we're evaluating our strategy holistically and piece by piece. We spent a lot of time listening to our agencies and our corporate customers, and we're hearing and we hear their feedback. We're taking some immediate actions to respond and adapt, and over the coming weeks, we'll be working to ensure that we're optimizing for our customers and American as we move forward. And just more on that in just a minute. Second, the domestic supply and demand imbalance has led to a weaker domestic pricing environment than we had forecast. There's more discounting activity than we saw a year ago. Now industry capacity is expected to come down in the second half of the year, and that should help. And finally, we expect that our own capacity growth would have been better absorbed as we moved into the higher demand summer months in the second quarter. But we haven't performed as we thought. And given this performance, we're taking a closer look at our own growth plans in the back half of the year and are making adjustments to bring our capacity down versus our prior plans. At this point, we expect to slow our rate of growth from just over 8% in the first half of the year to approximately 3.5% in the second half of the year. Against this backdrop, American is taking action to address our capacity and adjust our distribution strategy, and we're going to be very attentive to the marketplace as time goes forward. We're adapting our distribution strategy. While we all know that NDC, modern retailing, internet-based channels for selling our product is the future of airline distribution. But we move faster than we should and we didn't execute well. We regret that and the difficulties that it created for our agency and corporate communities. So we are going to modify our distribution strategy. Specifically, we need to work closely with our agencies and partners to ensure that the transition that we're making is not disruptive to our end customers. And to that end, we're focusing on 3 key areas as we evaluate our go-forward plan. First, just in terms of content, we know that our products are more easily understood and valued by customers when distributed through modern retailing technologies. But instead of removing content from agencies that are relying on legacy technology, we need to incent more to enhance and promote NDC. We've used a lot of [indiscernible]. We've got to put some more [indiscernible] in place and make sure that our product is available wherever customers want to buy it. Our agency and corporate relationships. We've made a lot of changes and we're reviewing everything on that front, including how we pay those agencies and how we solve problems that our mutual customers may have. We need to make it easier to participate in our programs and the easier to do business with American Airlines. For our end customers, that fly every day, we want to make sure that no customer that's out there traveling is made worse off from the changes that we make. And it's always been our priority to treat our customers in -- that they're flying in our seats as best as we possibly can. [indiscernible] make changes. For example, next month, we were going to differentiate who earned Advantage Miles and who didn't, based on where they booked, that's off. We're not doing that because it would create confusion and disruption for our end customer, and we're going to make sure that we take care. We're listening to feedback. We're learning and adapting. We know that NDC, modern retailing provides a better experience for the end customer. And we know that we will get there over time, but we have to go about it differently. We're going to make it easier, we're going to execute better and we're going to do a lot more to try to bring people along with us. To a degree our approach is driving customers away from American, we're unequivocally committed in getting those customers back. So there was other parts to do. So before opening it up, David, further discussion, I'd just like to address for a minute some of the other news that you've seen. So yesterday, we announced that Vasu Raja will be leaving the company in June. And I've known Vasu for a long time. He's admirers, creative thinking, his passion. He's been an innovator, a disruptor. He is a good friend, but sometimes we need to reset. And in this case, we do. We have to be better at executing those long-range plans. We have to be more attentive to the marketplace. We have to be more detail oriented, and we have to go forward as a team and really make it easy for American to do business with. So I am passionate about executing. We will absolutely innovate. We will swing for fences. It's essential in this business, but we have to produce in the short run to get to the long term. And right now, that means taking a look at our sales and distribution strategy and what needs to be done. That work is underway. And I'm really pleased with the team that we have that's out there taking this to task. We worked hard to build a reputation of delivering what we say we're going to do. We've done it from an operations perspective. We're going to do it from a balance sheet perspective. We're doing it from a cost management perspective. We're going to do from a commercial perspective as well. There's a lot more that we are evaluating right now. We're focused on maximizing the opportunities ahead of us. We'll refine our plans and be able to provide more of an updated view on our full year guidance as we progress and this will be [ in the ] July earnings as we get the second quarter. Thank you for the chance to speak.

All right. So maybe let's spend a little bit of time on some of the near-term stuff just because I think it is important to help investors understand kind of the state of the market and how much of this is consumer weakness versus how this is sort of self-inflicted pain and then we get into some of the strategic stuff. So you mentioned long term -- the full year guidance that was not noted in the call the update. So where does that stand at that table or?

Look, where we stand right now. We know we've dug ourselves a hole in the second quarter. Our operating earnings are going to be up by a couple of hundred million dollars. We've got a lot of work to do to recoup that. There is absolutely marketplace dynamics that are involved as well. As I take a look at the work that we have ahead of us. I believe that second quarter this hold down is partially related to how we -- it's partially related to the industry dynamics, more capacity than the demand is out there and softer pricing environment. The other piece is how we've executed in that, and I think that that's something that, that we can recover. We've got work to do. We'll talk more in second quarter as we produce those results. We've got some work to do on build them back from the hole we've created for ourselves. But I do believe as we take a look to the back half of the year, dynamics get better, capacity in corporates is much more moderated. You've heard us talk about pulling capacity down as well. The comps are certainly more favorable to American as we get out to the third and fourth quarter. So we're going to keep plugging away and we'll give you more information as we get to the second quarter.

And as we think about that -- the magnitude of the unit revenue is kind of in the second quarter from April to [ here ]. Things seemingly got a lot worse, right? So as you think about that step down, was that some of the things we noticed in the first quarter in terms of managed corporate bookings being a little bit weaker, accelerating and getting worse? Or like is there any way you can help us understand how much of it is really just Southwest [ out there ] with $39 fares versus kind of shot ourselves in the foot and not got even worse.

Well, I'd just say this, we should have performed much more in line with our network peers in the first quarter. And so I know that, that's an opportunity for us to recapture. But the marketplace has definitely gotten much more competitive and sale activity increased considerably after we produced -- we put forward our guidance and talked about our first quarter results. I don't know if it's 50-50, 60-40. Okay. But I'd tell you that a portion of this is marketplace. And I think that the dynamics in the industry get better from a capacity perspective as we move through the year. And then I think the other large portion is how we've reacted in that marketplace. And the weakness that you've seen in American is I do believe something that speaks to close-in bookings, the highest premium customers that, unfortunately, we haven't made ourselves as available and easy to work with as we can.

Okay. And as you think about that unit revenue weakness in 2Q thinking about what that means for third quarter right now. [indiscernible] the summer months or the time when we harvest and the right months at the time when we get ready to harvest. I mean do you think that the capacity adjustments you're making are going to be able to start to offset that by third quarter? Or is it going to take longer?

No. As I said, as we look into the third and fourth quarter, capacity dynamics get considerably better. And for our own, while we grew first half of the year. At about 8% back half of the year is just going to be about 3.5%. And I'll just say that we're going to be really attentive to it and then if we need to adjust capacity further, we will.

Yes. And was it sort of yield driven or load factor driven just on revenue.

Well, I'd say there is a little bit of both. Well, little bit of both but those customers that are out there want to fly. And so we've seen loads remain very, very strong. But there's work that we need to do to make sure that we're maximizing our ability to revenue manage off of that demand. And that's where it comes into American and our distribution strategy and making sure that we're taking full advantage of those that really aren't booking close in. And for us, that's a priority.

Okay. So turning to the cost side of the equation. Obviously, unit cost that's feel everything was actually a little bit better. It sounded like in the guide. Bringing the capacity down to 3.5% in the back half of the year, that's obviously going to put some upward pressure on unit cost? Or is there additional stuff you're working on right now to kind of accelerate and mitigate the down risk as we pull in.

David, at our Investor Day, we talked about the reengineering efforts at American, and I'm really pleased with what I see on that front. So not only are we running the most reliable airline, I kind of give a shout out to our team for the incredible work that they've done. You know the load factors over more of the weekend, but you also know the catastrophic weather that hit various parts of the country, especially Texas and Oklahoma. Our team has done a wonderful job on that front. But as I take a look at our ability to reengineer, we're doing it in a fashion that preserves our ability to run a fantastic airline. And at the same time, also make sure that we have the right capacity in the right places for when we adjust our commercial strategy. I know that we're going to perform well. As we take a look at the potential to pull down any capacity, I do believe that we're going to be able to hold our cost in mind. And then comes out of my confidence in the work that we're doing from a reengineering perspective. Capacity reductions always have some impact on costs. We're going to do our best to make sure that we mitigate those to the greatest extent possible. Everything that I see from our work on reengineering the company, making sure that we're making best use of our fleet, I'm very encouraged by it.

Okay. So let's talk about the network distribution changes and stuff like that. Obviously, it seems like from the outset looking in and based on what you just said, you weren't getting the results you wanted from the steps we've taken. Can you, at a very high level and briefly summarize the changes that you made? And how long it's going to take to undo them.

Okay. Let me start first with this just in terms of network. I believe that American has just a fantastic set of assets. And we talked about those. We've got strong domestic presence at this regional network that others can't duplicate. We've got partnerships in international network that's very well with that. There are dynamics in the industry, we always have to be conscious of. So for instance, we have a very large franchise that is based in the Sunbelt. And by Sunbelt, it's really Caribbean, MCLA, Short-Haul International. That has been an area that has had a lot of capacity over the last year, ours included. And I do think it's something that's going to shake out. When you take a look at that region, our unit revenue performance has been down considerably. But it's not something that we're going to abandon. We're going to make sure that we're there when the dynamics change. But looking around the rest of the world, Transatlantic is doing well. As we take a look down at South America and in Asia, we see unit revenue performance that is roughly in line with year-over-year. And so I feel strong. I feel good about how American is set up to compete. I love our assets. In terms of the execution side of things. I'll tell you this, we have to make sure our product is available for sale in all channels. We're going to be making some changes very quick. So I think that, that is something that is immediately reversible. I believe that in terms of rebuilding relationships, I think our intermediaries and these are the TMCs and our corporate customers as well. I think that we're going to have to get out there and really get on the road and make sure that we move quickly. That's going to take a little bit of time.

So that is going to requires kind of rebuilding that corporate sales team and kind of getting more feet on the street? Or is it going to be more managed from the corporate office because I know you guys have made some changes to reduce expense in that area. That's supporting the distribution changes, just wondering like directionally, are we changing that back.

No, what I would tell you is because we could take a little bit of both. And to that end, I believe that we have the resources to actually manage and to react quickly. We have to -- for instance, we have to make sure that when we're putting new technology out and asking our travel management companies to come along with it. We need to make sure that we have the technical capability to help them get there as well. We need to adjust things that I talked about were fewer sticks and more carats. We're not going to be taking away the ability for any customers to earn mileage. And those are the kind of things that I think are going to have an impact very quickly and I do believe that getting our products out and available in all channels is something that we can do very, very quickly.

Okay. So then -- last question on the sort of the near term and then we can [indiscernible] some of the bigger picture issues around the industry dynamic. You've made the decision to part ways with [indiscernible]. Can you just talk about your goals, expectations kind of mandate the new person is going to have to come in. Someone that you want to come in and sort of redesign everything. Is there somebody wanted to implement what you've already -- adjust which you've already [ won ] like how do we think about the mandate that you're going to be giving whoever. [indiscernible] you want to commit to take that job and what's the mandate.

Okay. Let me just start with this. First off, our strategy is the company strategy. Those are my strategies, okay? And so I'll leave any individuals aside from that. And I do believe that the strategy that we're pursuing that we laid out in Investor Day are the absolutely right ones. Now one of the things that is very clear is that we've driven some customers away. We restricted some customers from actually [indiscernible] our product. Those are kind of things that we have to be attentive to. It's one thing to have a plan and that plan can be the greatest plan in the world. You can have the best people operating it, but execution is critical. Being able to react through changes in the marketplace is critical. Attention to detail is critical and operating as a team going forward is critical. I will tell you that my view is that we have done an exceptional job of running a reliable airline. And I know that, that has been something that's been hard to do to get back after pandemic and we've held ourselves accountable to it and we delivered. It's hard to run a very cost-efficient airline in this business. I've tasked our team with doing that, and they have delivered. From a commercial perspective, we will do the same. We will deliver. We must be better at executing our strategies. It is the right thing to encourage our customers to avail themselves of all the products and services that American Airlines can offer. That is something that does take technology. It does take modern retailing tools. But we can't be blind to that ultimate goal. We have to make sure we're reactive in the short run, and we can never be difficult to do business with. So the same expectation that I have from an operation perspective, the same expectation I have from a cost perspective. We will have -- we have that same expectation from a commercial perspective, and I know that we'll be able to achieve it. In regard to how we do that. We don't need more strategies or new ideas. We need to execute on those ideas, we [indiscernible] better. We have fantastic people. Vasu recruited a wonderful team, actually very confident in that team. And I also feel very confident in our plan right now with Steve Johnson coming in and making sure that we're assessing and reviewing everything. I've been around this business for a long time. You're going to see me start to pay a lot of attention to how we produce revenue day in and day out. All of that is being bringing about better execution and also guide us in terms of our thinking on what we need as we go forward.

Okay. And then as you think about coming out of this period of transvendor maybe kind of ratcheting down the growth, right? What should investors expect you to be looking for to when you feel like you have license to grow in. Well, what is that -- is there a metric you're running for? Is there a margin metric return metric? What is the -- like right now, obviously, the market conditions aren't great. The performing peers on a relative basis on the margin side maybe [indiscernible] capacity. When do you change that?

So first off, we run this business for the purpose of producing profits -- producing higher margins. We are -- that philosophy hasn't changed. We're not going to run an airline that's based on a lot of development flying and a lot of testing. We're going to make sure that we run this airline for profitability, short run and long run. As we've gone back from the pandemic, I'll just say, it's been a pretty interesting ride so far. There's been changes in terms of supply chain. There has been changes in terms of the operating environment and the capacity of the air system. There's been changes -- positive changes in terms of the way the customer has come back. I want to be in a position to really take advantage of that. So what are one of the changes in the way the customers come back, there's a lot more demand for premium product. okay? Our fleet is set up to take advantage of that. Our network is set up to take advantage of that. We have to make sure as well that we are able to sell into that. And so as I take a look at our profitability, one of the things that we have to do is reestablish our competitiveness among the top network airlines. That's where we ought to be perceived and measured and ultimately, that's going to be the driver or the limiter on growth. So where we've gone from prior to pandemic, through the pandemic and where we are today. You know that we've grown back finally to get to where we were in 2019. We've produced capacity to really fill out those hubs that probably too much utilization in shoulder season flying in. We're going to go and make adjustments on that. As I take a look at into next year, we have a very flexible fleet plan. My expectation is that we're going to regain our footing in terms of profitability and that will be the driver in terms of growth that we produce in coming years.

That's a great segue into one of the bigger picture topics I want to dig into a little bit today around sort of premiumization segmentation and what that opportunity set looks like to you? I sort of view this as the industry capturing some of that numerous [indiscernible] that has been out there as you were just selling kind of one ticket to everybody one price and not being able to discriminate as much. When you think about the kind of runway that American has specifically to go after that relative to peers who are enjoying a better sort of [indiscernible] performance as a result of that. What are the yardsticks or the benchmarks we can look at how much opportunity is for you to actively kind of close that.

Yes. Well, just in terms of premium revenue. As I mentioned in my comments that we have been able to grow front cabin revenues at more or less the pace of more capacity growth. Clearly, others are doing better than that, okay, and that should be the expectation for us as well. So that is, first and foremost, it's close in bookings. It's business travel, and it's those that we want to do business with us and buy our premium product. We've got a great fleet. It's set up to be able to accommodate growth in the front cabin as we take a look out through 2026 from our fleet overall. We have preceding growing by about 20%. And if you take a look at our long-haul capability, our long-haul fleet capability, we're growing front cabin by about 30%. We'll be ready to take advantage of that, and my expectations are that we're going to be able to produce.