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LCC AT A GLANCE

P/E ► -0.814   EV/EBITDA ► -48.9   ROA ► -4.7% LOW ROE ► -1130% VERY LOW Debt to Equity ► -30.8   Current Ratio ► 0.807 AVG Interest Coverage Ratio ► -1.17 LOW

 

 

 

 

 

 

US Airways (NYSE: LCC) is a major domestic air carrier, which as of April 2008 operates 3,800 flights to 230 destinations across the U.S., Canada, the Caribbean, Latin America and Europe^[1]. The company’s finances suffered considerably due to reduced air travel following September 11th, forcing the airline to declare bankruptcy in 2002^[2]. However, unlike other carriers that improved and emerged stronger following Chapter 11 protection, US Airways never fully recovered. The combination of high fuel costs and tough labor negotiations forced the company into a merger with America West in 2005. While the US Airways name was maintained for brand purposes, the merger actually left America West executives and stockholders with more control over the new company^[3].

US Airways has responded to the low fare revolution in domestic air carriers by attempting to cut costs and revise its route structure. The company has adopted increased point-to-point flights along the east coast and instituted fees for basic amenities (headphones, food, etc.). These cost saving measures in combination with cost savings from the merger and increasing travel demand led an ~$800MM increase in operating income from 2005 to 2006. The airline's ability to continue to manage its costs is less certain, however. In 2008, the company's 30,000+ employees formed a coalition to demand higher wages and better benefits (Source??). Normally, airlines negotiate with their employees through separate unions (flight attendants, pilots, service workers, etc.). By forming a single body to negotiate on their behalf, the employees will be able to exercise greater bargaining power. During the same period, fuel prices reached an all time high.

Like the rest of the legacy airlines, US Airways is facing soaring fixed and variable costs in a time of falling revenues. After reporting a $236 million loss in the first quarter, the company has been forced to take drastic measures to ensure continuing operations and debt coverage. US Airways is now in the second phase of their cost cutting, and are cutting the work force by 5% and fourth quarter 08 mainline capacity by 6-8%.^[4]

Business Financials

The financial history of US Airways is somewhat skewed by the 2005 merger with America West, which resulted in a massive increase in operating revenue. Nevertheless, revenue has increased every year from 2004 through 2007. The growth was motivated primarily by higher load factors that resulted from a decrease in capacity across the entire industry. Moreover, significant fare increases during 2007 helped to push operating revenues upward^[5].

Operating income has also been influenced by the merger with America West, climbing from -$217 million to $558 million in the year following the merger. The improvement in income has resulted from better revenues for reasons outlined above and not due to a reduction in expenses. The unprecedented rise in fuel costs has forced operating expenses upward during the entire period analyzed, but the increase in revenues has outpaced that rise, thus allowing for positive operating income numbers^[6].

US Airways Group Annual Report^[7]

US Airways Group Annual Report^[8]

Key Trends and Forces

Increasing Fuel Costs

Double United's Fuel Costs: Fuel expenses represent one of the largest and most variable costs faced by airliners. From 2004 until 2007, fuel costs have climbed from 13% to 31% of US Airways's total operating expenses^[9]. The company has attempted to employ hedging strategies to reduce the pain of oil price increases, but the success of these investments has been quite mixed. In 2007, the airline’s oil price hedges reduced overall fuel expenditure by $245 million; however, the hedges lost nearly $100 million during 2006. ^[10]. Continued oil price increases will pressure the carrier's profitability, given that its 2008 purchase contracts offer only a limited 28% hedge against higher oil prices. ^[11].

Competition from Low Cost Airlines

US Airways has long been structured as a legacy carrier; the company has existed for decades, operating a hub-and-spoke network as well as a separate regional airline. This business strategy was the industry standard until the middle of the 1990’s, when US Airways and other legacy carriers began to face pressure from low cost airlines. US Airways responded by adopting a new “Metrojet” service, which operated limited single class no-frills flights quite similar to those offered by Southwest. However, the company’s broader business model remained the same, and the “Metrojet” service proved to be short lived. Thus, the competition from discount airlines remained, forcing US Airways to search for new ways to cut costs, especially as operating profits dropped in the post-September 11th period. In an attempt to reduce expenses, US Airways moved away slightly from the hub-and-spoke structure and began offering more point to point flights. However, the high costs continued and will continue, especially with respect to labor expenses. Benefits and wage costs for the airline increased by 10% from 2006 to 2007, and are expected to continue rising in the near term due to the increased bargaining power of the US Airways employee coalition^[12]. Labor expense increases of this type are especially painful for US Airways, given that salaries and benefits are already 23% of operating expenses^[13]. Moreover, the company has announced plans to introduce improvements to their in-flight service, which brings into question the carrier’s ability to sufficiently reduce costs.

Mergers in the Airline Industry

Delta and Northwest announced in April 2008 that they will be pursuing a merger of their two companies. While the proposed consolidation still faces the hurdles of a shareholder vote and government approval, it is quite possible that it will be completed and encourage further consolidation within the industry^[14]. Given its 2005 merger with America West, US Airways is unlikely to pursue any direct action in response, but the new Delta, with more routes and economies of scale, will become a more serious competitor. Moreover, analysts have suggested that the Delta merger will encourage a similar consolidation between United and Continental , which would create another strong competitor for US Airways^[15]. However, talks between Continental and United fell through. Immediately following this, merger talks between US Airways and United began. But after nearly two months of negotiations, it appears as though this deal is also falling through. Sources have cited possible labor union opposition and high integration costs as deterrents for the merger.^[16]

Increased Government Regulations

The Federal Aviation Administration (FAA), an agency of the federal government, is charged with providing oversight for airlines operating in the United States. During the early portion of 2008, it was revealed that the FAA was not active enough in ensuring airline compliance with safety inspections. As a result, there has been a strong Congressional backlash, which will likely force the FAA to become stricter in guaranteeing airlines perform safety checks. ^[17]. While US Airways has not been forced to cancel flights in order to comply with the new demands from the FAA, the increased intensity of inspections will probably result in an enduring increase in expenses for the airline and the industry in general.

Competitors

Operational terminology unique to the airline industry includes available seat miles (ASM), revenue per available seat mile (RASM) and cost per available seat mile (CASM). The three metrics are determined as follows:

RASM and CASM respectively allow for comparisons across airlines for unit revenue and unit costs. In the battle between low fare carriers and legacy airlines, companies like Southwest and Jetblue have found ways to reduce CASM (through lower maintenance costs from a more uniform aircraft fleet type and a “no frills” customer experience) while legacy airlines continue with their historically higher CASM operating strategy. Thus, even if both types of carriers manage to fill seats and achieve similar RASM, the low fare airlines will achieve greater profitability from their lower cost structure.

Market Share

US Airways is the seventh largest airline in the United States, capturing 4.7% of the domestic commercial airline market. The top fifteen U.S. airlines by market share are ranked below, where market share is measured in terms of domestic revenue passenger miles.

Notes

1. ↑ US Airways 10K, Item 7, pg. 34
2. ↑ US Airways 10K, Item 1, pg. 5
3. ↑ US Airways 10K, Item 7, pg. 38
4. ↑ Reuters
5. ↑ [ http://www.sec.gov/Archives/edgar/data/701345/000095015308000353/p75006e10vk.htm , US Airways 10K, Item 7, pg. 40]
6. ↑ [ http://www.sec.gov/Archives/edgar/data/701345/000095015308000353/p75006e10vk.htm US Airways 10K, Item 7, pg. 41]
7. ↑ US Airways 2007 10K, Item 6, pg. 30
8. ↑ US Airways 2007 10K, Item 7, pg. 48-50
9. ↑ US Airways 2007 Annual Report, Item 7, pg. 41 and US Airways 2006 Annual Report, Item 7, pg. 49
10. ↑ US Airways 2007 Annual Report, Item 7, pg. 41
11. ↑ US Airways 2007 Annual Report, Item 7a, pg. 65
12. ↑ US Airways 10K, Item 7, pg.41
13. ↑ US Airways 10K, Item 1, pg. 11
14. ↑ “Delta, Northwest Approve Merger” CNN April 15, 2008
15. ↑ USA Today, "Continental, United Ready if Others Merge, Sources Say"
16. ↑ http://www.reuters.com/article/businessNews/idUSWEN598820080530?feedType=nl&feedName=usbeforethebell
17. ↑ “Fliers Fume as American Airlines Grounds Another 595 Flights Friday” Fox News April 11, 2008
18. ↑ Reutersretrieved July 7, 2008.