Airline Stocks Plunge After American's ‘Worrying Precedent’ on Payby
Carrier drags down industry stocks after granting raises
JPMorgan sees blow to ‘it’s different this time’ viewpoint
American Airlines Group Inc. sent industry stocks reeling after unexpectedly granting pay raises to pilots and flight attendants -- a move seen as weakening the case that carriers are poised to generate steady profits.
The pay bumps will add $930 million in costs through 2019, American said. Chief Executive Officer Doug Parker reversed his earlier opposition to increasing compensation before labor contracts expire, following months of pressure from employees who argued they were falling behind counterparts at rival carriers.
Stepped-up compensation at the world’s largest carrier is fueling doubts about airlines’ ability to avoid spiraling costs and cash in on industry consolidation that’s supposed to lead to steady returns after decades of boom and bust. Berkshire Hathaway Inc., billionaire Warren Buffett’s company, became one of the biggest shareholders in American and its rivals last year, rewarding Parker’s efforts to woo investors with the promise of a new era for airlines.
The compensation action “establishes a worrying precedent, in our view, both for American and the industry,” Jamie Baker, an analyst at JPMorgan Chase & Co., said in a note Thursday. “In our minds, this is a seminal event, and represents the first credible potential blow to our long-held ‘it’s different this time’ investment thesis.”
Higher pay could reduce American’s 2017 earnings by 29 cents a share and 2018 results by 46 cents, said Baker. He cut his recommendation on American to neutral from overweight.
American tumbled 5.2 percent to $43.99 at 2:04 p.m. in New York after dropping as much as 8.6 percent for the biggest intraday decline in 10 months. A Bloomberg index of U.S. airlines fell as much as 4.3 percent, the most since Jan. 30.
American said it was bringing compensation in line with the highest pay rates at its primary rivals after significant gains last year by employees at Delta Air Lines Inc. and United Continental Holdings Inc. Doing so meant granting increases before labor contracts for pilots and flight attendants expire in the next few years. The changes need union approval.
“We believe there is some risk that they think they should be paid more than Delta and United employees,” Helane Becker, an analyst at Cowen & Co., said in a note to clients. “Giving pay increases out of negotiations is risky and could backfire.”
Parker said sweetening compensation would lead to better customer service and improve American’s fortunes in the long term. The CEO has struggled to improve a long history of strained management-labor relations at Fort Worth, Texas-based American since assuming control of the airline after its 2013 merger with US Airways.
Years before he took over, workers agreed to concessions in an effort to save the carrier from bankruptcy, only to learn that top executives had received bonuses and pension protection. After the company filed for Chapter 11 in 2011, unions accepted a second round of givebacks. Parker has acknowledged that workers still don’t trust managers.
“It’s a move that might surprise or even dismay some of you because it adds costs to the airline, but we couldn’t be more convicted about doing it,” he told investors and analysts on a conference call after announcing earnings. “This increase in our near-term expenses in no way changes our view about our long-term prospects.”
Costs for each seat flown a mile are expected to climb 5 percent this year, American said. The previous forecast was for a 4 percent increase.
American isn’t the only carrier wrestling with higher expenses.
Southwest Airlines Co.’s costs jumped as higher wage rates took effect for pilots and flight attendants under contracts ratified last year. The Dallas-based discounter is also investing in a new reservation system.
Costs for each seat flown a mile climbed 6.9 percent even after excluding the effect of oil, special items and profit-sharing, Southwest said in a statement. That was at the high end of the company’s forecast.
“We remain intensely focused on controlling costs,” CEO Gary Kelly said in the statement. He said the pressures should “abate dramatically” later this year.
Kelly rejected the view that American’s move set a risky precedent, saying labor contracts sometimes need to be adjusted before their expiration.
“We make changes, historically, all the time,” he said on a conference call to discuss quarterly earnings. “Is it a dangerous precedent? No. It is a framework. The only way it works is if you have a true partnership.”
Southwest fell 1.9 percent to $55.88. An earlier decline of as much as 4.3 percent was the biggest intraday slide since November.
Investors were probably disappointed by Southwest’s cost outlook on higher employee wages and fuel prices and its lack of progress in improving average fares, said Logan Purk, an analyst at Edward Jones.
“Those combined are a bit too much of a headwind for Southwest to offset,” he said in an interview.
The airline reported first-quarter adjusted earnings of 61 cents a share, missing the 63-cent average of analysts’ estimates compiled by Bloomberg. Sales rose 1.2 percent to $4.88 billion, falling short of the $4.92 billion anticipated by analysts. Unit revenue declined 2.8 percent. The airline had forecast it could drop as much as 3 percent.
Cost pressures are squeezing American just as it’s finally strengthening its grip on fares.
Revenue for each seat flown a mile, a proxy for pricing power, will rise 3 percent to 5 percent in the current quarter, the carrier said in a statement Thursday. That would be the third straight gain in the benchmark measure as American emerges from the aftermath of a fare war that erupted in 2015.
American reported first-quarter adjusted earnings of 61 cents a share, topping the 57-cent average of analyst estimates compiled by Bloomberg. Sales were $9.62 billion, in line with estimates.