US Airways Profits Are Not as Impressive as They Seem
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US Airways (NYSE: LCC) reported above consensus profit for Q4 on Wednesday. Adjusted EPS of 26 cents was double the Q411 figure, in spite of losses related to Hurricane Sandy, and beat the consenus estimate of 19 cents. This drove the stock up above $15, to within striking distance of 52-week highs. This caps a remarkable run for US Airways; just fourteen months ago, the stock price had fallen to just $4.
A ticking time bomb?
In spite of the apparently strong earnings results, US Airways is not a stock that I am interested in owning. The company faces a very unstable situation because it has a heavily unionized workforce that is significantly underpaid relative to the competition. US Airways has benefited from its labor groups's militance, because they have been unable to agree upon and ratify new labor contracts for many years. While workers at competitors like Delta (NYSE: DAL), United (NYSE: UAL), and even bankrupt AMR (OTC: AAMRQ.PK) have gotten big raises, US Airways employees are working under bankruptcy-era contracts.
For a long time, US Airways management has stated that they have a revenue disadvantage vis-a-vis their three larger competitors, which requires them to have compensating cost advantages. This primarily refers to lower labor costs. This argument might have been tenable last year, when US Airways posted adjusted EPS of just 68 cents on razor thin margins. However, the company's profit quadrupled this year, catapulting it to near the top of the industry in terms of profit margin. This gives labor a strong argument for more lucrative contracts. Thus, the higher US Airways' profit today, the more its costs will increase in the future. If US Airways refuses to budge, the National Mediation Board will eventually permit the labor groups to strike, which would cripple the company.
How big a gap?
US Airways has a substantial cost advantage vis-a-vis other network carriers. Since United and American are both in the middle of restructuring their labor contracts (due to merger integration and bankruptcy, respectively) I will compare US Airways' labor costs to Delta's. The best measure for comparison is labor cost per available seat mile (ASM). However, this measure actually understates the US Airways cost advantage, because Delta has a significantly longer average stage length, which means that costs are spread over more ASMs.
For the quarter just ended, US Airways spent $600 million on labor and had 17.5 billion ASMs. The company's labor cost per ASM was therefore 3.42 cents. By contrast, Delta spent $1.83 billion on labor expense and had 47.5 billion ASMs. Delta's labor cost per ASM was thus 3.85 cents. By this conservative estimate, a move to rough parity would have increased the US Airways quarterly labor bill by more than $75 million. Over the course of a full year, the additional labor expense would reduce US Airways profit by more than 50%!
Moreover, the profits earned today are not safe. While US Airways appears to be doing very well for the time being, the excess profits being earned because of favorable labor contracts are unlikely to be captured by shareholders. It is standard practice in the airline industry to offer labor groups a large signing bonus when they are working under long-expired contracts. The signing bonus is meant to compensate workers for the raises that they would have otherwise gotten. United Continental's recently ratified pilot contract reportedly included a $400 million lump sum payment, or roughly $40,000 per pilot. US Airways could conceivably have to pay more, as its pilots have been working under expired contracts for a longer period of time. At just $40,000 per pilot, US Airways could see a bill for more than $200 million in a year or two. Moreover, that accounts for just one of several work groups (albeit the highest paid by far).
Investors should thus realize that US Airways profits are almost wholly due to advantageous labor contracts that are unlikely to last. Management clearly hopes to merge with American Airlines in order to increase revenue and hopefully offset the looming cost increases. However, the upside in a merger is not sufficient to offset the risks of higher future labor costs for US Airways.
Adam Levine-Weinberg owns shares of Delta, and has sold March $14 calls in Delta. Adam Levine-Weinberg is also short United Continental. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!