American Finds a better way to hedge

[jcw]

http://seekingalpha.com/article/3600586-american-airlines-group-finding-a-better-way-to-hedge-fuel-costs

 

[FWAAA]

Thanks for posting this. I didn't write the article for Seeking Alpha, but I could have, as it matches exactly what I've been posting here ever since AA announced the huge new plane orders in the summer of 2011.

You can hedge fuel, but that's risky and you have to keep doing it constantly. And you might lose spectacularly, like DL and WN and UA have over the past 12 months.

As the author pointed out, a long-term hedging method is to buy new fuel efficient aircraft that tend to burn less fuel per seat mile, like A321s instead of old 757s and 787s instead of old 767s. Since aircraft have to be replaced eventually at every airline, might as well bite the bullet and get it over with, and save fuel in the process. Add in the maintenance holiday new aircraft bring and you save labor costs.

Not often mentioned is the environmental benefit, as the new planes reduce fuel consumption rather than successful hedges, which encourage airlines to fly less-efficient planes which do more harm to the environment.

If fuel drops further and stays low for a long time, then AA's refleeting strategy won't pay off quite as well as if fuel stayed very expensive, but even with very low fuel prices, AA still benefits some from the fuel efficiency plus the maintenance holiday plus the environmental impact. On top of that, this article points out the very low interest rates that AA is paying on new long-term debt, and that's nothing to sneeze at.

Yes, used 717s and MD-90s are almost as fuel efficient as new jets, but another airline has basically cornered the market on those and bought up all the available copies, and so AA doesn't have the option of buying several dozen 717s and MD-90s, as that ship has long sailed. AA's only choices are to buy new fuel efficient planes or fly old planes and hope that fuel hedging gains make flying them affordable.

 

[jimntx]

Excuse me, DL did not lose spectacularly on fuel hedges over the last 12 months.  What appears to be a loss to you commoners is actually the fruition of a strategic investment designed to reduce taxes, or moonthumbs per available seat gallon, or something else.  But, it was not a loss--spectacular or otherwise.

 

[DNTULSA]

WT,
 
Is the above poster  you?

 

[jimntx]

No, it's me (an AA employee) beating WT to the punch.  We all know that Delta is like the Virgin Mary--without sin or error.

 

[FrugalFlyerv2.0]

I'll bet you $5 that a certain DL fankid cheerleader will soon be making multiple posts spinning the numbers and making up new metrics, which will ultimately show just how much better DL is.

 

[topDawg]

Thanks for posting this. I didn't write the article for Seeking Alpha, but I could have, as it matches exactly what I've been posting here ever since AA announced the huge new plane orders in the summer of 2011.

You can hedge fuel, but that's risky and you have to keep doing it constantly. And you might lose spectacularly, like DL and WN and UA have over the past 12 months.

I have always liked how Parker lets it ride (for the most part) on hedges. Delta does well on hedges when fuel is high but then end up taking huge losses when fuel dips. I feel like at the end of the day it evens out but I still don't want something I am investing in taking MTM losses of billions and thinking its okay. 
Playing the game is fine, but don't be at 50-50 win/losses. 
 

As the author pointed out, a long-term hedging method is to buy new fuel efficient aircraft that tend to burn less fuel per seat mile, like A321s instead of old 757s and 787s instead of old 767s. Since aircraft have to be replaced eventually at every airline, might as well bite the bullet and get it over with, and save fuel in the process. Add in the maintenance holiday new aircraft bring and you save labor costs.

I agree on the mirco of just fuel costs. Some what on maintenance costs.
In MX, checks start (hangar checks) start 18 months in. They are pretty short visits (on narrow bodies) but they still happen. I think the idea of this maintenance holiday is a little bit of a joke. If you are a carrier like DL and AA who do a lot of work in-house the money you save from not doing the heavy heavy work ends up being blown on tooling, facilities, staffing and training. 
However on the macro of the airline, ownership, acquisition, leasing are also a huge part of this. I also believe in getting a ROI or do like some of the other airlines do and turn the assets when they are young (6-12 years) so that the selling price is still high and they get the ROI that way. 
 
In this fuel environment I would MUCH rather see AA slow down on the fleet turn over and take that capex and put it toward the balance sheet. The main reason I wont touch AAL and UAL is that balance sheet. They are not working nearly as hard as DAL to get it cleaned up. Also, IIRC, AA has ALOT of its fleet leased (from burning the furniture to heat the house pre-BK) and I believe a large amount of the big fleet order is also planning to be leased. 
I'm not a fan of airlines not owning a lot of its assets. 
 
 

Not often mentioned is the environmental benefit, as the new planes reduce fuel consumption rather than successful hedges, which encourage airlines to fly less-efficient planes which do more harm to the environment.

meh its a feel good thing but really does nothing for you. I highly question if the crowd that might pay a little more for this is large enough to make it worth while. 
 

If fuel drops further and stays low for a long time, then AA's refleeting strategy won't pay off quite as well as if fuel stayed very expensive, but even with very low fuel prices, AA still benefits some from the fuel efficiency plus the maintenance holiday plus the environmental impact. On top of that, this article points out the very low interest rates that AA is paying on new long-term debt, and that's nothing to sneeze at.

I don't think fuel has to get much lower. Didn't AA change there plan a little for the long haul fleet already (deferring 787s)? I know UA has changed its fleet plan a little, buying used 73Gs/319s and keep 767s around. 
 
 
however, one thing a lot of people are forgetting, The nitrogen kits for the fuel tanks are going to start being a real issue in a few years. That is a big investment and it will be make or break for some of these older (but not done) aircraft. 
 

Yes, used 717s and MD-90s are almost as fuel efficient as new jets, but another airline has basically cornered the market on those and bought up all the available copies, and so AA doesn't have the option of buying several dozen 717s and MD-90s, as that ship has long sailed. AA's only choices are to buy new fuel efficient planes or fly old planes and hope that fuel hedging gains make flying them affordable.

 The 717 and MD90 are both rare cases, and I honestly am not sure they would have been a good fit for AA. (at least the direction Parker wants to go) 
 The MD90 has a LOT of issues with it maintenance wise. IMO the only reason Delta finally started buying them used was because we finally started getting all the bugs worked out. DL had a good lead time on AA to get those bugs worked out and IMO it would have been a big gamble for AA to take them on. 
The 717 also has some issues. Well that me say that differently, the BR715 is a turd on a high cycle aircraft. It is a engine originally designed for low cycle flying. DL has been working with Rollers to get PIPs done but when DL took them on from FL/WN the TBOs were ~18months. (CFM56 is about 4-5 years from comparison). This is a big reason why the engine will be coming in-house vs going to RR for work (the original plan was for them to be PBH engines). Again, if Doug is wanting to get out of the maintenance business I'm not sure they would have been a wise choice. 
On top of all of that, Delta will be keeping its JT8D powered Maddogs around for a while and AA seems hell bent on dumping them ASAP, which is going to jack part prices up compared to DL. 
 
As we talked about in another thread, I think the E90 is the best bet for AA. Its low risk, already have them in the fleet and can probably get a good/great deal from EMB to add more than 20 to fleet. 
Also, I agree with Anderson, I think we are going to have a big narrow body bubble in the next few years as NEOs and MAXs start coming in big numbers, AA might also be a mover in this market. (buying not selling) 

Excuse me, DL did not lose spectacularly on fuel hedges over the last 12 months.  What appears to be a loss to you commoners is actually the fruition of a strategic investment designed to reduce taxes, or moonthumbs per available seat gallon, or something else.  But, it was not a loss--spectacular or otherwise.

         Jim wins. 

 

[WorldTraveler]

and over and over what is lost is that new airplanes cost money.

The industry has long bought aircraft with a 15-20 year lifetime with some foreign carriers leaning more to the shorter end of the range.

The economics of buying new aircraft in today's $50/bbl crude oil environment just don't work - but since those aircraft were ordered a half decade or more ago, there is nothing that can be done to get rid of the orders.

and the growth ability of the industry is FAR less than the number of aircraft on order so there will be lots of good, current generation aircraft that will be available in the near term - which is why Richard Anderson said that he sees a significant bubble coming in the widebody market that could well spread ot the narrowbody market before long. The ME3 are simply not creating additional demand - they are taking it from other airlines who won't be ordering aircraft a few years down the road.... but in the meantime there will be a big bubble that will provide enormous opportunities.

AA will have a shiny new fleet - but it is interesting that few of the people who have long touted WN as being such a barnstormer in the industry note that they have a pretty old fleet compared to the average of the big 3.

New aircraft cut a lot of costs - maintenance for a short time, fuel costs if fuel is high - but adds a whole lot of expense to the balance sheet that will have to be serviced.

The big difference between AA on the one hand and DL and WN on the other is the leverage on the balance sheet that Wall Street considers as a major difference in why they value AA a lot lower than DL or proportionately lower than WN. UA is somewhere in the middle but moving toward the DL/WN philosophy of lower aircraft costs.

 

[FrugalFlyerv2.0]

In this fuel environment I would MUCH rather see AA slow down on the fleet turn over and take that capex and put it toward the balance sheet.

 
I think the numbers I saw from airsafe.com, the AA average fleet age will be ~11-12 years, which is in line with some of the European carriers (LH, SK, AF, KL), a bit younger on average than North American carriers, but still well behind Asian carries (JL, KE, CX) which seems to buy/sell/lease aircraft like cars :-0

 

[topDawg]

 
I think the numbers I saw from airsafe.com, the AA average fleet age will be ~11-12 years, which is in line with some of the European carriers (LH, SK, AF, KL), a bit younger on average than North American carriers, but still well behind Asian carries (JL, KE, CX) which seems to buy/sell/lease aircraft like cars :-0

And one thing to remember about the Euro carriers is it looks like they are about to go through our 2001-2008 time frame. The only thing they have working for them is the lack of a 9/11 type event and fuel prices have gone down. 
 
Labor/management is a mess, LCCs are capacity dumping like crazy on the short haul, ME3 is capacity dumping on the long haul. Some of the countries are falling apart etc. etc. etc. 
 
Why I say this is I imagine you are going to see more deferrals of aircraft.
 
 
and yes, the euro LCCs and Asian carriers do quick turn overs. 

 

[commavia]

In this fuel environment I would MUCH rather see AA slow down on the fleet turn over and take that capex and put it toward the balance sheet. The main reason I wont touch AAL and UAL is that balance sheet. They are not working nearly as hard as DAL to get it cleaned up.

 
It's notable how 180-degree counter this is to the unabashed and unapologetic philosophy being advocated by Parker and Kirby.  When asked about the balance sheet, time and again the position has been that when debt is as cheap as it is, it's better to finance new aircraft because they generate returns far in excess of the sub-4% cost of money.
 

As we talked about in another thread, I think the E90 is the best bet for AA. Its low risk, already have them in the fleet and can probably get a good/great deal from EMB to add more than 20 to fleet. 

 
I don't necessarily disagree - the 190 may well be a good fit.  Only thing I'm unsure about is the maintenance issues I've heard about that some other airlines - though not, I don't think, USAirways? - have had with the jet.

 

[topDawg]

It's notable how 180-degree counter this is to the unabashed and unapologetic philosophy being advocated by Parker and Kirby.  When asked about the balance sheet, time and again the position has been that when debt is as cheap as it is, it's better to finance new aircraft because they generate returns far in excess of the sub-4% cost of money.

 Wall street has yet to agree with them. As much as I hate to say what ^he^ has said, look at the deference in market caps and IIRC investment grades.
 
Parker seems to be short terming this airline. I would be a little worried if the economy turns. 
 
and IMO making sure he lines his pockets with stock buy backs. 
 

I don't necessarily disagree - the 190 may well be a good fit.  Only thing I'm unsure about is the maintenance issues I've heard about that some other airlines - though not, I don't think, USAirways? - have had with the jet.

The older jets have issues. 
I am not sure how US does with its fleet. 
 
I will however say Delta's plan with the older E90s from AC is, just like the 717, do a lot of work in-house and work out the bugs. The big difference is Delta already has a CF34 shop where the BRs are new engines for DTO.  

 

[commavia]

 look at the deference in market caps and IIRC investment grades.

 
Hear you, but there are lots of confounding variables in there that can explain some or all of the difference in market cap and investing ratings.  I'll be interested to see where things stand in, say, five years, after AA has the merger far in the rear view mirror.
 

Parker seems to be short terming this airline. I would be a little worried if the economy turns. 

 
Once again - hear you, but perhaps this is precisely the reason why, concurrent with taking on historically-cheap debt to finance new, margin-accretive, NPV-positive aircraft (low fuel and maintenance costs more than offsetting higher ownership cost), AA is also stockpiling a massive mountain of cash (>$9B and counting as of 3Q)?

 

[topDawg]

Hear you, but there are lots of confounding variables in there that can explain some or all of the difference in market cap and investing ratings.  I'll be interested to see where things stand in, say, five years, after AA has the merger far in the rear view mirror.

I don't disagree with the first part,
but unless AA changes its balance sheet plans I still see Delta being a better looking company 5-10-15-20-30-35-40 years from now (assuming they don't change what they do.)
 
 

Once again - hear you, but perhaps this is precisely the reason why, concurrent with taking on historically-cheap debt to finance new, margin-accretive, NPV-positive aircraft (low fuel and maintenance costs more than offsetting higher ownership cost), AA is also stockpiling a massive mountain of cash (>$9B and counting as of 3Q)?

yeah I'm not one of those finance people who love tons of cash while you build debt. IMO that is what has gotten airlines into trouble before.

I'd much rather see AA take 5-6 billion of that cash and pay of debt.

 

[WorldTraveler]

Wall street has yet to agree with them. As much as I hate to say what ^he^ has said, look at the deference in market caps and IIRC investment grades.
 
Parker seems to be short terming this airline. I would be a little worried if the economy turns. 
 
and IMO making sure he lines his pockets with stock buy backs. 
 
The older jets have issues. 
I am not sure how US does with its fleet. 
 
I will however say Delta's plan with the older E90s from AC is, just like the 717, do a lot of work in-house and work out the bugs. The big difference is Delta already has a CF34 shop where the BRs are new engines for DTO.

Wall street has yet to agree with them. As much as I hate to say what ^he^ has said, look at the deference in market caps and IIRC investment grades.
 
Parker seems to be short terming this airline. I would be a little worried if the economy turns.

given the significant gap in market cap between DL on the one side and AA and UA on the other, Wall Street absolutely sees DL doing things that AA and UA are not.

it's pretty simple and Wall Street looks solely at the numbers