American Airlines CEO's wine-bottle wager with UBS is looking dicey

Doug Parker, chief executive of American Airlines Group Inc., probably needs to start sharpening his wine-selection skills.

In 2016, Parker wagered a bottle of wine that American would hit $60 a share before UBS Group AG analyst Sam Buttrick turned 60. With Buttrick's birthday looming Nov. 25, American is languishing at less than $40 a share after falling the most this year among major U.S. airlines.

Losing the bet is the least of Parker's worries.

His airline is trailing Delta Air Lines Inc. and United Continental Holdings Inc. on key operational and financial measures, prompting another Wall Street analyst to label American the "bronze medal" carrier. Also under increased scrutiny: the airline's hefty debt, and its insistence that it can earn at least $3 billion before taxes even in tough years.

"More so this year than any other, they have been getting push back from investors saying in this cycle, we don't want to deal with airlines that are so levered," said Savanthi Syth, a Raymond James Financial Inc. analyst. "Now that they are under performing on revenue as well, that exaggerates the concern on the debt side."

Buttrick declined to comment on the CEO's bet. Parker acknowledged in a conference call last month that American had just stumbled through its most challenging quarter since merging with US Airways in December 2013. Higher fuel prices, a burden for the entire industry, added $700 million to second-quarter costs. A June computer outage at a regional unit grounded 3,000 flights.

Gap in pricing power

American trailed Delta and United for the second straight quarter in growth of revenue for each seat flown a mile, a crucial gauge of pricing power. That gap, which reverses an advantage American held since late 2016, is projected to widen in the second half. It's also trailing its biggest rivals in pretax profit margins, as well as operational performance in on-time flights and mishandled bags.

The company said it was lagging in the U.S. market and cut its 2018 profit estimate for the second time this year.

"We can't gloss over it — we're not performing day in and day out for our customers as I'd like," President Robert Isom told company pilots in an Aug. 8 meeting.

In an interview Monday, Isom said the company is already seeing "great signs" of progress in its efforts to increase sales, cut costs and improve product offerings.

American expects a boost as it completes its integration with US Airways, including greater scheduling flexibility for flight attendants. The company is targeting $1 billion in cost-savings programs through 2021, as well as moves to bolster revenue by $1.1 billion this year and $975 million in 2019.

"We have so many initiatives that we've outlined," Isom said. "They take awhile to get in place. On that, I'm not going to apologize. We want to make sure we are doing things in a prudent fashion."

A few challenges in the industry are hitting American harder than its rivals. Market weakness in Latin America, where the Fort Worth, Texas-based airline has the largest presence among U.S. airlines, is one. American has also suffered from unusual discounting by crosstown rival, Dallas-based Southwest Airlines Co., which cut fares as it suspended marketing and social media promotions following a fatal accident in April.

American is taking steps to shore up its short-term outlook. It's joining other airlines in tapping the brakes on expansion this year and next, betting that slower growth in the seat supply will make it easier to boost fares. It will drop some poorly performing international routes, including in markets such as China and Brazil.

The company's more judicious growth will be focused on its largest hubs in Dallas-Fort Worth and Charlotte, N.C., where it dominates flying and can add service without raising costs much. It has delayed 22 new aircraft to spread out future capital spending. Next month it will drop a carry-on bag fee for its "basic economy" discount fare after discovering it was losing customers to Delta, which had no such charge.

"As they execute on those and show evidence they are having some success, the market will be much more kind to them," said Samantha McLemore, a portfolio manager at LMM, which holds American, United and Delta. "We expect some of the valuation discount would close."

Another area of concern is the balance sheet. American has $19.2 billion net debt, which it accumulated primarily by buying almost 500 new aircraft since the 2013 merger. That compares with $9.3 billion at United and $6.2 billion at Delta, according to data compiled by Bloomberg.

"Obviously, it's an overhang," said Chris Terry, a portfolio manager at Hodges Capital Management, which owns American shares. "You've got $1 billion in interest expense a year, and have to make sure you can service that debt every quarter."

American has said that amount will decline each year now that its fleet renewal program is winding down. The airline maintains a hefty cash cushion as risk protection, and touts the $30 billion value of its aircraft assets.

"We've invested more in our fleet and our airports and our lounges and our people than anyone else has over the last three years," Isom said. "When we take a look at what we have in terms of assets, we'll go toe to toe with anyone."

Challenging the premise

A single rocky quarter "is not symptomatic of a problem," said Jack Atkins, a Stephens Inc. analyst. More worrying is that American's latest cut to its profit forecast is raising skepticism of Parker's pledge that the restructured airline will produce pretax profits of about $3 billion in weak years, $5 billion in average years and $7 billion in good years.

"It's understandable to be frustrated with the 3, 5, 7 billion," Atkins said. This year, "their guidance implies something below 3 billion."

Ultimately at stake is Parker's thesis that the airline industry has fundamentally improved for investors through consolidation, which should soften the financial peaks and valleys and yield steady earnings. Investors are still skeptical.

"I don't see any evidence in the markets that people believe that to be the case," McLemore said. "If you look at the valuations of airlines today, they still trade in line with long-term historical multiples."