Bleeding out
The bloodbath that is today’s pandemic stricken airline business was on full display last week as the last of the three big US network carriers reported their Q2 results. Earlier in the month, Delta had kicked off the results season with a rather eye-catching $7 billion headline pre-tax loss.
How did the figures from American and United compare and what do they tell us about how well each is managing the crisis?
Reported losses
On the United Airlines earnings call (rather ill-named as there weren’t any earnings to be seen), CEO Scott Kirby boasted that his team had delivered the best results of all the big three. That is certainly true if you look at the headline losses, with losses before tax of “only” $2 billion in the quarter.
The results of all three carriers were heavily impacted by “special items” (about which more in a moment). Excluding these gives a much more comparable measure of the core airline performance and on that basis the three carriers look much more similar. To be fair to Scott, United still comes out ahead, with losses of $3.1 billion, over a billion better than American.
Special items
So what are all these “special items”? The first and most interesting of them is the payroll support payment grants the carriers have been given by the government under the CARES Act. In total, the three carriers are eligible to receive over $11 billion of non-repayable grants for 2020, much of which was received in the second quarter. Both American and United released about half of the total grant to the profit and loss account in the second quarter, offsetting a little over 70% of their payroll expenses for the period. The other half was held on the balance sheet to offset costs in Q3. For some reason, Delta only booked about a third of its total grant money to profit and loss in Q2, presumably because they intend to release the money over three quarters rather than two. If Delta had followed the same approach as American and United, its reported results would have been about $0.6 billion better.
The other big special items charged to operating profit were $350m of severance costs at American and $2.5 billion of fleet write-offs at Delta. Below the operating loss line, Delta also booked losses of over $2 billion due to write-downs of their equity investments in LATAM, AeroMexico and Virgin Atlantic.
Revenue performance
Scott Kirby was particularly proud of the performance of his commercial team and has been critical of the approach taken by American Airlines, his previous employer. American took a much more aggressive approach to adding back domestic capacity in the second quarter than either of the other two, operating almost two and a half times as much domestic capacity as United.
United’s tightly controlled approach to capacity definitely delivered better yields. They actually managing to deliver an increase in domestic yields compared to last year of over 30%. By comparison, domestic yield fell 22% at American. But they did less well on seat factors, dropping by 52 points compared to last year to only 35.7%. American achieved seat factors of 44.1% with a network strategy that emphasised restoring enough flights to get its big connecting hubs working again. With low fuel costs and front line labour costs fixed until the end of October, arguably the most important metric to get right was to maximise absolute revenue. On that basis, American’s strategy proved to be the superior one, delivering domestic passenger revenues of over $1 billion, almost $0.5 billion higher than at its competitors.
Where United definitely hit a home run though was in cargo. At both American and Delta, cargo revenue fell by over 40% as wide body capacity was grounded. However at United, they put a real focus on operating cargo only flights and managed to grow cargo revenue by 36% compared to last year thanks to a staggering 128% increase in cargo yields.
Delta was king of the “other revenue” performance for the quarter, with that category bringing in $300m more revenue than at the other two airlines, almost certainly due to its refinery business where third party sales jumped to almost $300m as capacity was no longer needed for Delta’s own use.
Adding it all together, the three carriers’ total revenue in the quarter was remarkably similar, despite the big differences in detail. However, at this stage of the crisis revenue performance was never going to be the thing that makes the difference. With revenues down by over 85% at all three carriers, limiting the value destruction was all about how well cash costs could be minimised.
Which brings us to the final metric on which to compare performance - cash burn.
Cash burn comparisons
The three companies all report cash burn metrics, but none of them are quite comparable.
The Delta approach is the easiest to reconcile back to the reported cash flow statement. They make two adjustments. First they exclude CARES Act grant money. Then they exclude financing transactions, that is proceeds from new debt, equity raises or sale and leasebacks. Likewise they exclude debt repayments including lease payments.
United takes a very similar approach. The only real difference is that they include repayments of existing debt in their definition. Funnily enough, that is a figure which makes little difference for them whilst hitting the other two.
American's metric differs from Delta's approach mainly by excluding new aircraft purchases. They argue they are only taking aircraft with committed financing, so the impact on cash is small. In the second quarter, American was the only one of the big three to have material cash outflows for that line item, so they would have looked very bad if they had used either of the other two carriers’ definitions.
In terms of gauging how much money the core operations are losing, I'm going to use the American airlines definition. Unfortunately for them, they still look like the worst performer, with daily cash burn in the quarter of $55m compared to $41m at Delta and $36m at United on the same basis. Those differences might not sound like much, but the difference between American and United of $19m a day added up to $1.7 billion in the quarter.
Where is this difference coming from? The first thing to remember is that these cash burn figures are calculated after adding back the CARES Act payroll support payments. Without the wage subsidy from the government, all three of these carriers would have moved to furlough employees months ago. American had the highest wage bill going into the crisis and is also entitled to the largest payment. American's employee costs in the second quarter were $2.5 billion, $368m higher than at United. Assessing cash burn on a "pre CARES basis" tends to penalise American accordingly. However, it does highlight the larger challenge that employee costs will represent for American once the CARES money dries up.
Even excluding employee costs, operating costs were $673m higher at American than at United. Over 40% of that was down to higher aircraft rental costs - American has a lot more aircraft on operating leases than its competitors and doesn’t seem to be making any progress in reducing its costs. Aircraft maintenance expense is another area of poor performance. Despite most of the fleet being grounded, costs only fell by 50% at American compared to a cut of 74% at United and 90% at Delta.
So who gets the prizes for Q2 performance?
Overall, I’m going to award American’s network and commercial team the prize for best domestic passenger revenue performance in Q2, although Scott’s approach will probably work better in Q3 given what is happening right now with the pandemic in Texas and Florida.
United’s team definitely wins the cargo performance award, delivering 70% more revenue than the other two airlines did between them.
On costs, United seems to have done the best from what I can see and this is translating into the lowest cash burn, however you measure it.
American comes out the worst overall on cash burn, fundamentally due to its worse cost position and higher existing leverage. Unfortunately, it can ill afford to be trailing behind the others. At the end of Q2, its net debt stood at $22.7 billion, slightly more than the other two carriers combined. It also has the least headroom to raise equity capital, with a market capitalisation of less than $6 billion compared to $10 billion for United and $17 billion for Delta.
There is an old adage about not needing to outrun a bear as long as you can run faster than your companions.
The team at American might need to speed up a bit.
