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Morningstar | American Looks to Streamline Operations in the Face of a Softening Yield Environment

U.S. legacy airlines generated returns below cost of capital until a post-recession shake-out and wave of consolidation allowed four carriers--American Airlines, Delta Air Lines, United Airlines, and Southwest--to capture nearly 80% of the U.S. domestic market, which ushered in record profit margins and consistent value creation. Indeed, U.S. airline profit margins set records in 2015 on the back of falling oil prices, rationalized supply, and fares that remained elevated.After absorbing US Airways, American grew larger than Delta and United on an available seat per mile basis; enhanced its network with hubs like Charlotte, where American controls over 60% of the flight capacity; but also saw its operating costs rise. In the years after the US Airways merger, realizing efficiencies and expanding margins has become American’s highest priority. American expects over $4 billion in revenue and cost improvements through 2021. We assume the carrier will generate moderate success from these initiatives as American has already reaped much of the benefits from increased cabin segmentation. We also anticipate American will see benefits from deepening feed routes at domestic hubs and by cutting unprofitable routes like Chicago to Shanghai.We believe American’s network optimization and growth initiatives are crucial to the success of its loyalty program, which we think makes a significant operating income contribution. American will need to maintain success of its frequent flyer program, if it wants to continue cleaning up its balance sheet. We expect margin improvement from American on the back of successful cost and revenue initiatives in tandem with its highly profitable frequent flyer program. Although we don’t award airlines moats, we believe improved core airline operations and lucrative loyalty programs will allow carriers like American to log profits for many years to come.