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It’s a great time to be running a US airline

Derek Kerr
REUTERS/Lucas Jackson
Blue skies ahead?
  • Natasha Frost
By Natasha Frost

Reporter

Published This article is more than 2 years old.

For almost three decades, Derek Kerr, the chief financial officer of American Airlines, has been deep in the financial details of US airlines.

After a few years as a flight test engineer, he joined Northwest Airlines in the early 1990s, during a period when the company only narrowly avoided bankruptcy by instituting significant wage cuts. Next, a move to American West Airlines, where he eventually became CFO in 2002. Here too, the airline was in the red, seeking nearly a billion in loans after first a weak economy and then the attacks of Sept. 11, 2001 delivered a sucker-punch to the industry. A later merger with US Airways in 2005 heralded a new age of airline consolidation, with struggling competitors forced to band together to balance their books.   

It was yet another merger that brought Kerr to American Airlines in 2013. At the time, American, an industry giant founded in 1926, had experienced billions of dollars in losses and weathered two years of bankruptcy; its $17 billion merger with US Airways created the world’s largest airline, with a market cap of about $12.7 billion and nearly 130,000 employees.

In the years since, American Airlines is flying high, with five years of profitability and plans for both domestic and international expansion in the offing. 2019 has been a little stormier, however. Troubles with the Boeing 737 Max hit the carrier hard, while significant, ongoing contract disputes with unions led to alleged intentional work slowdowns and caused a summer of disruption. Risks around environmental concerns and possible government regulation remain on the more distant horizon. 

Quartz interviewed Kerr in New York. He told us what airlines can’t control (and what that means), why US airlines have a profitable edge on their European counterparts and what he believes is the biggest puzzle facing the industry.

This interview has been lightly edited for clarity.

Quartz: For people who may not be following American Airlines’ financials all that closely, how are things?

Derek Kerr: Things are pretty good. We’ve had issues with the Maxes being up and the operations this summer but from a second quarter perspective, we went above our guidance and we were very happy with where the second quarter came out. 

From a revenue perspective, we are on the 11th straight positive RASM (revenue per available seat mile) quarter. And we finally, from a second quarter perspective, had margin expansion, which we haven’t had in a long period of time. So we’re very encouraged by where we are, from a financial perspective. From a cash perspective, we’re over $8 billion in liquidity—very stable and profitable. We have a lot of things to work on still, as we go forward, but where we’re at today is much better than where the industry has been in the past.

With things as stable and as good as they are, it seems like there are a lot of things that could go wrong. I think about, for example, the shock to oil prices the other week. (The average airline spends about 25% of its operating costs on fuel, up from 15% in 2016.) Is that an ongoing risk that you’re concerned about?

Yeah, I think it’s there all the time. We have to watch it. But in the last five years, we’ve been in this $50 to $60 a barrel range, and it hasn’t moved. There has been a lot of shocks and a lot of things that have happened—you saw it go up to $70 and come right back down to $64 today. The shale producers in the US have taken up a lot of that capacity, which has been great. 

We worry about it, and we watch it, but I think where the industry is today, you can withstand certain things like that—short-term, definitely. In the long-term, we would react to it by pulling capacity and doing things that are further out there. But I don’t think there’s anything other than that. If it were a 9/11 event, then yes, that’s something that you’re not going to plan for, and hopefully that never happens again. But the one thing in our industry that we can’t control is the economy and fuel. What you have to do as a company is control what you can control, and make sure you are controlling the cost, and everything else that’s there, and driving revenues as much as you can. That’s the focus of the company as we go forward. 

We will react as an industry to things that happen—if there is a recession, which we haven’t seen any signs of, or if there’s a fuel price shock, which would need to be $60 to $100 or $80 to $100. With $60 to $70, we manage in that: earnings come down a little bit, and prices change over time, but those types of environments, we’re always looking at and worrying about as we plan out the next two to five years.

Are there any other significant risks that are on the horizon for you?

We do all have labor contracts that are coming up—we’re negotiating them and doing a really good job of keeping those in line—but I don’t think there’s any other big risks that we worry about other than those two. Within our circle, it’s more competitive: What our competitors are going to do and where are they going to go, and those kinds of things. 

I’m interested in whether you consider, for example, the European flight shaming movement, in which customers don’t fly, to be a risk and whether it’s a risk that is possible to model.

It’s hard to model, without a doubt. It is a risk that we have to look at, how we are going to react from an environmental perspective in the US. I think it is definitely becoming more of a topic and a discussion topic at the airline level, but I think it’s impossible to model. I don’t know how we build that into our long range, five-year plan as we move forward. 

We don’t plan for it in a financial perspective, but we need to look at it and be aware of it and make sure that we are on top of those things.

I wondered whether it was a concern for environmentally-minded investors, whether that’s come up.

Not really, not yet. But there are environmentally-conscious investors who say, ‘Okay, what are you doing? What is your sustainability report? What are you putting out each year, and where are you going in that?’ It’s becoming a bigger deal. And it’s something that we are more focused on as a company and I think all US companies are more focused on.

It seems like there’s quite a lot of opportunity for growth there—that if you can find a sustainable balance, it’s something which could be quite positive for both the image of the airline, as well as for your financials, if you can find a way to diversify away from being so reliant on oil.

Correct. It definitely is. It’s hard—if you think about it, oil, that’s what the engine flies on, right? In today’s world, alternative fuels are more expensive than the fuel we use today. 

But as we look forward, I’m sure there will be opportunities and we can go with a renewable fuel with a better energy footprint. That will help, it’ll help the environment, it will help everything as we move forward. We’re looking at it all the time.

There are governments around the world that are considering placing fairly significant regulation on airlines, in terms of emissions and their environmental impact. I wonder whether that’s something which American Airlines is thinking about. 

Yeah, we are thinking about it. We know what’s going on in Europe. We know what we will need to comply with over time, and we’re looking at that. What we have done over the last few years in bringing in 500 brand new aircraft—we’ve retired older MD-80s, we’ve retired 767s, we’re going to retire Embraer 190s. We are doing that, whether we are forced to do it or not, and looking at the environment from that perspective. We do believe that something will come and we have to be prepared for that as we go forward.

There is a popular conception that it is not possible, or at least very difficult, to run a profitable airline. Is that true? I think about, for example, certain carriers in Europe who are especially in trouble.

No, I don’t think that’s true. There’s a difference between the US and other areas, say Europe, at this point in time. 

The US has gone through a complete restructuring over the last 10 years. We went from 12 airlines down to six—now, four carriers have over 80 or 90% of the capacity. We have struggled over time, and consolidated into the hubs that we have, and gotten out of unprofitable flying, and things like that. Now, I think the US domestic industry is very profitable and it’s going to be profitable for a long period of time. There will be shocks, it’s still going to be a cyclical industry, but it’s off of a different base, instead of it being off of barely breaking even, with shocks up and down of that. We’ve made around $4 billion a year for the last five years, and so has Delta, so has United. So has all the industry. Even the low cost carriers are profitable in the US.

Now, the model in Europe is different. It’s harder to consolidate in Europe—it’s harder, and you have a lot more players. Is that going to happen in Europe? I don’t know. Carriers like Norwegian were trying to do things that may not have been profitable, and they’re just going to have to figure that out. 

The shakeout has happened in the US, airlines have gone away and airlines have merged, whereas it hasn’t happened in Europe. It’s two different models today. Where the industry is, US-wise, is significantly better than where it’s been in the past, because we know who we are, and we’re not flying unprofitable things. Through the mergers, we decreased flying and got the industry righted.

American Airlines is a testament to that. 

All of us are, I think. Delta and Northwest merged, United and Continental merged. We’re all stronger than we were by ourselves. American Airlines was in bankruptcy when we [US Airways] did the merger. And they were struggling and trying to figure out what their path was and by putting us together, we were able to become a profitable airline.

I asked you about some of the risks ahead—what are the opportunities for growth?

We have significant opportunities for growth. The hub structure in the US is much more powerful than we had thought: Dallas is very significant for us, Charlotte is very significant for us, DC is profitable for us. We have the opportunity over the next three years to grow those airports [by adding gates and flights] so we have significant growth in our most profitable airports, which is really big. We call it filling in the box: throughout the Midwest, throughout the southeast, opportunities to fly out of those areas. 

The bigger the hub gets, the more connecting passengers you can have, and then the more international you can fly. It’s all about what the size of the hub is. Atlanta is very strong for Delta. Newark is strong for United. We all have our spots, and I don’t think those are going to change from an industry perspective. Now, what we need to do is make sure that that’s the strongest it can be. 

We got 16 new gates at Dallas, which is unheard of. We started that growth this summer—we grew 6% in the first month, and RASM was up 1.6%. When you’re growing that much, you don’t think you can keep the pricing power up. We did, and that’s just continuing. It shows us that that growth is there and we have the ability to do it. We’re really excited about it. That will enable us to fly more to Europe, because we’ll have the ability to bring more passengers into the hub and take them out. The new XLRs that we just purchased from Airbus—we’ve turned some of our A321neos into XLRs, which will give us more distance to fly more routes into Europe. 

Those are the opportunities that we have as we go forward. We also have our alliances and keep strengthening our alliances—getting the Qantas deal done that we just got done, having the JAL (Japan Airlines) relationship and the IAG (International Airlines Group) relationship, and just making those stronger.

Can you talk me through how you’re approaching the Boeing 737 Max problem? 

Yeah. We’re staying really close to all the government agencies, we’re in discussions weekly, if not daily, with government agencies and with Boeing to understand where we are in this situation. We adjust plans as we hear. We’re very confident right now, from the information that we have—it’s a lot of information everybody has, we may have a little bit more—that we will be able to fly these aircraft on December 3rd. We’ve taken the schedule and we push it out as we get further information. 

The two things that we want to make sure happen: Number one is, we want to make sure our customers are protected, so we need to make sure that that change happens far enough out. For Thanksgiving holiday, we needed to make a decision three months earlier, so all the passengers that have tickets on Thanksgiving can be rebooked on other flights and make sure that they get to where they need to be. We need to make the same decision for the holiday in December.

But at some point in time, we have to make a decision to take care of not only the customers, to make sure that they’re getting where they need to be during the holidays, but our employees. We set up a schedule for the pilots and the flight attendants two months out and we say, ‘okay, here’s where you’re gonna fly and here’s where you’re going to go.’ We don’t want, all of a sudden, to make the changes. When we first put it down, it was very disruptive, because we were doing it in real time, week by week, what’s going to happen. Now we’re planning more, December 3rd, we’re planning two, three months out, just to make sure that we take care of them.

That’s what we’re doing. We’re just working with them to make sure that when it flies again, it’s safe and ready to go. We’re all behind that to make sure it gets back up here.

Are you concerned about customer nerves about flying on the plane?

It’s going to happen, early. There’s no doubt about it. But I do think if the FAA is out there saying, ‘it’s ready to go’; if our pilots, the union pilots, are behind it and say it’s ready to go—I mean, we’re not gonna fly this plane unless our pilots say, ‘Hey, it’s safe and it’s ready to go.’ No pilot ever takes a plane up that they don’t think is safe. 

There definitely will be some customers that know it’s a Max, and may not want to fly it. We’ll have to help that customer get onto another aircraft, and make sure that they get there. I think over time, [with] what this plane is going through, it’s going to be the safest plane in the sky. It really will, in the end, because it will have gone through all of the rigors that it needed to.

I think there will be a perception, early. Over time, I hope that that goes away and people understand that this is a very safe and reliable plane, that there hasn’t been any instances on it. But we’ll have to deal with some customers. There are some customers that have no idea what plane they’re on, there are some customers that know exactly what plane they’re on and what number plane it is. We’ll work through that as well.

Twenty-five years from now, what’s going to be different in this sector?

I’ve been doing this for 30 years, right? Back 30 years ago, it was all: We are going to fly supersonic, and we’re gonna fly with no pilots in the cockpit, and we’re gonna do all that kind of stuff, and it just hasn’t happened. So—I don’t know! Are we going to get down that path? Are people ready for a one pilot cockpit, or no pilots in the cockpit? I don’t know about that. They’re not ready for nobody in a car yet, I don’t think. 

But the technology is going to get better. The product’s going to get better. We’re going to be able to invest more in the customer, and do those kinds of things. Hopefully you get to a point where you can get to the airport, and never see anybody [in security] and get right on a plane. Our CIO showed us a video she made in 2005, I think it was. It was that exact same thing, 14 years ago: biometrics, getting on the plane, ‘I just have to go through a door’ security. But we’re nowhere near it. So hopefully we get some kind of advancement in that kind of stuff to make the process at the airport a little bit better for our customers.

[Delta CEO] Ed Bastian has talked a lot about Delta’s commitment to free in-flight Wifi. Is that something American Airlines is interested in?

It’s something we’re looking at. The differentiator between airlines is going to be how you treat the customer and what you do for the customer—we all do the same thing, right? We all fly, we all can get anybody anywhere they want in the world. So, from a customer’s perspective, it’s how do we treat our people, do our people treat the customers better, and that kind of stuff. 

That circle is all the stuff we’re working on—how do you create a world class customer experience, so the customer wants to come back and fly you all the time? Wifi is a similar thing. You have to work with the manufacturers to make sure that it works. We started out with Gogo on airplanes, to give people a chance to have wifi. The problem was, the bandwidth wasn’t big enough, and so if you had too many people on the plane using it, it shut down and it was a terrible experience. You’d get on and you’d try to do your work and you couldn’t do it. 

Now we have Viasat, we have streaming, and we have a much better product on the plane. Is the bandwidth there? It will be eventually. But is it there yet today, so that if you provided free Wifi to everybody and everybody on the plane used it, that the experience works? The last thing you want to do—it’s very frustrating to have a product on play that’s not working, if you tell a customer that this is what you’re going to have, and it doesn’t work.

The customers will demand certain things as we go forward. New flyers will demand different things as we go forward. How we adjust to that is what is going to differentiate us as airlines. And we all will do that, we’ll all invest in that. 

On that note, what is American Airlines’ unique selling proposition? Why should I fly with you instead of anybody else, given that you’re all doing functionally the same thing? 

Oh, I think it’s our people. Our people are fantastic. [CEO Doug Parker] has set out a goal to change the culture at the airline, make culture a competitive advantage. We have invested in our airline more than anybody else has in the history of aviation, bringing in 500 aircraft, bringing the product, putting the wifi in place, putting the clubs in place, and doing these things with the customers in mind. Our proposition is we can get you anywhere you want to get, we have great relationships in IAG and Europe and everywhere else. And our people are the best out there, to get you to where you want to be.

Which other airlines do you admire? 

I think Delta does a really good job of running a really good operation. They’re seven years ahead of us in the merger. From an operations standpoint, we admire them for what they’ve done. We admire Southwest for what they do from a people perspective. If you think about customer service type of things, you think of Southwest. If you think about operations, you think about Delta. So those are kind of the two, when we look at where we want to get to. We’re getting there and we’re pretty darn close to both of them.

Lastly, what’s the most interesting question that you face right now? What’s the most interesting puzzle, or challenge, or opportunity? 

The most intriguing puzzle is the Max. It really is. Figuring out, number one: when does it come back? And your question earlier: will people fly it, and how do we go down that path? There’s a lot of things we can control in this industry. That’s one thing we can’t control, right now. As we look forward to plan for 2020 and what we’re going to do in 2020, you have this big huge unknown. We think it’s coming back up and it’s going to be there—but when?

Boeing has made 350 aircraft that are sitting up in Seattle that haven’t even been delivered yet. The 24 aircraft we have on the ground that we have, there’s another 16 supposed to come. So when do those come? How do you plan for next year? This profitable growth I have in Dallas and Charlotte and DC—how do we plan that out, with this unknown? Trying to put that proposal together is not easy.

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