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The Plane Truth

As they flew US Airways through bankruptcy, managers of the old America West reduced the fleet and sparked an industry trend.
Roy Harris, CFO Magazine
October 1, 2006

From fuel prices to terrorism threats, in recent years the list of woes sapping profits from airlines and driving some into bankruptcy could fill volumes. But in one sense, a single problem says it all: too many planes.

Excess capacity undercuts fare structures and deflates the key metric of revenue per available-seat-mile (ASM). Carriers with the most planes become the biggest losers.

So when America West Airlines merged with bankrupt US Airways Group Inc. in September 2005 and put America West's managers in charge, part of their plan was to pare their combined fleet, slashing expenses and "sizing" the new US Airways to compete vigorously as a low-cost carrier. Among airlines that offer limited amenities, it would enjoy the same skies so friendly to LCCs (low-cost carriers) such as Southwest and JetBlue. Slashing labor costs was central to the bankruptcy process, of course. But the new, merged US Airways also was at the forefront of another industry trend — capacity reduction — practiced by airlines both bankrupt and solvent, both low-cost and full-service.

A year has passed since CEO Doug Parker and CFO Derek Kerr, former high-school friends from Michigan, flew US Airways out of Chapter 11 (see "The Long Haul," CFO, February 2005). Its strong profit levels so far have surprised even them, as a number of factors fell into place: an $860 million recapitalization exceeded their target by $330 million, synergies have run ahead of schedule, and traffic has increased industrywide. More important, US Airways's renegotiations with General Electric's leasing arm have enabled the airline to cut its fleet by 15 percent, to 359 planes.

"Without the bankruptcy process," says Kerr, "we would have ended up having 60 too many aircraft."

Significantly, Tempe, Arizona-based US Airways insisted that the planes be reassigned to foreign markets, helping cut overall domestic industry capacity. That was important because fare increases take better hold in an environment without excess seats. And US Airways's fleet reduction has helped lead a recent shrinking trend among nearly all American carriers. "Because of that, you've seen 8 to 9 percent price increases stick across the industry," says Kerr.

In a rare case of harmonic convergence among fierce competitors, in fact, industry goals and individual airline goals are served by reducing ASMs. United Airlines emerged from bankruptcy in February with 107 fewer planes. Delta Air Lines and Northwest, still in Chapter 11, have sharply pared their fleets, too (see "The Bankruptcy Diet" at the end of this article).

No Folding Required
For years it was assumed that if industry capacity were to shrink by the needed 20 percent or more, it would be because some major carriers folded, according to airline analyst Helane Becker of The Benchmark Co. "If you look, that much has come out of the system. It just hasn't been in the form of an airline going out of business." Reduced capacity underlies the airlines' return to profitability in the face of soaring fuel costs this year — in US Airways's case, resulting in profits far beyond its postbankruptcy forecast.

For passengers, of course, fewer planes and more demand mean crowded flights. In a stark example of how empty seats are the exception rather than the rule — compared with four years ago — Becker points to the United plane that was diverted in mid-August from a London-to-Washington flight because of a passenger's suspicious activity. It was flying 92 percent full, now a typical load. "The planes involved in September 11 had just over a 20 percent load factor," she notes, which is almost unheard-of today.

Any airline would be happy with US Airways's financial results in its first year out of reorganization. It watched its market capitalization grow to $4 billion from near zero, while second-quarter net income soared to $305 million. "The merger model we used projected that we would make $150 million for the full year," says CEO Parker. The entire industry did well by doing less fare-discounting, which offset soaring fuel costs, but US Airways benefited more than it expected from merger synergies. (Some labor and other merger-related issues are still unresolved.)

Parker's enthusiasm for the US Airways reorganization — raising "the greatest amount of new equity that any airline has put together at one time" — is what led him to call Delta CEO Gerald Grinstein last July about possibly combining the two airlines. "Consolidation makes sense," Parker says, "and it makes the most sense when one of the airlines is in bankruptcy." Delta said it was not interested, but Parker insists that if any such merger opportunity presents itself, "we don't want anyone to dismiss us out of hand just because we have our hands full."

Cash for Flexibility
Another priority in US Airways's recapitalization was cash. "We really structured the acquisition to reduce the transaction risk by building the upfront cash and not having demands on those dollars," says Parker. The airline has accumulated $2.2 billion in unrestricted cash. "We have more cash than most of our competitors, which is really important in this business, particularly in difficult times," he adds. The importance of staying liquid was a lesson learned after 9/11, when fixed costs ate up cash as airlines first were grounded and then flew nearly empty. The foiled terrorist plot in London this past August, the CEO says, "highlights once again how important it is to have a strong balance sheet."


The entire industry got the message. "If you look at every airline's balance sheet, you see more cash," analyst Becker says. "American has a $5 billion cash hoard on $20 billion of revenue for 25 percent. The unrestricted cash at US Airways is almost 30 percent. That's not a bad thing in this environment."

Associate professor Robert Shumsky, a transportation specialist teaching at the Tuck School of Business at Dartmouth, notes that financial strength is for naught "unless you have an employee base that focuses on keeping costs low."

In the past, that focus was not a US Airways hallmark. CFO Kerr and CEO Parker see the reborn airline's task as creating a cost-aware culture from scratch. "US Airways was thrown together by the combining of airlines," says Kerr. "The culture on the America West side was low cost, but the US Airways side was not quite there."

A step in that direction is its new stock symbol: LCC. The choice was aimed at employees more than investors. "It's aspirational," says Parker. "It's meant to be a statement of where we want to be."

Roy Harris is a senior editor at CFO.


The Bankruptcy Diet
Domestic fleet size before and after airlines reorganized
Airline Prebankruptcy Fleet* Filed Current Fleet* Shrinkage
United Airlines 567 12/02 460 18.8%
US Airways 419 9/04** 359 14.3%
Delta 522 9/05 457 12.5%
Northwest*** 433 9/05 371 14.3%
*Mainline
**2nd filing; 1st filing was 8/02
***Includes international fleet
Source: The companies



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