The US Big Three must pay more attention to cargo to satisfy their shareholders

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There is a strong sense of pride, as well as rivalry, in the US airline industry. Details matter, but it doesn’t look like any of the major players – the so-called Big Three – is paying enough attention to some hidden assets in their portfolios – namely, cargo assets.

Closely monitored by investors, suppliers and customers, the largest US carriers have fought hard in recent years to survive and then to secure the lion’s share of the market to the apparent benefit of their shareholders, who have recorded outstanding returns since the end of 2013, after a very difficult stint in the wake of the credit crunch five years earlier.

Ever since, the US airline industry has gone through big changes, as testified by the merger between American Airlines and US Airways – a tie-up that created the biggest carrier in the world, in a deal that was inconceivable until the early years of the century, but granted survival to both in 2013.

Now all the major carriers are looking at expanding their core passenger businesses abroad rather than drafting survival plans, which is a great achievement, really, but here at The Loadstar we also wonder whether they could kindly provide us some clarity on their cargo plans in Europe and elsewhere.

After all, from players such as Delta Air Lines, American Airlines and United – which control the majority of the US domestic market – you should expect some big news at any time about strategy, both in their core passenger business and in cargo. In fact, with regard to the latter, these three carriers could easily exploit their sheer size to boost their cargo operations both Stateside and elsewhere – or am I completely wrong?

If FedEx is shelling out top dollar on TNT in Europe, why shouldn’t they?

Cargo news of the month

If big news in cargo is what you are after, then check out Time magazine’s headline last week: “Airlines Ban Big Game Trophies from Cargo After Cecil the Lion Deathnews.”

Time’s article pointed out that the ban is on “all lion, leopard, elephant, rhinoceros and buffalo ‘trophies’,” adding that Delta, United and American announced on Monday that they would no longer allow such shipments.

Time magazine’s wasn’t the only headline that caught my attention. “The killing of Cecil the lion in Zimbabwe triggered mounting global outrage,” Bloomberg reported. Luckily for those bullish on cargo trades, the BBC’s headline came out: “Cecil the lion: Why a hunting ban is not the answer”.

The death of Cecil won’t hurt the profits of the three US carriers, so that’s a relatively easy trade to abandon overnight, but Delta, American and United should nonetheless state their intention with regard to their cargo units, which are rather small on a global scale but may contribute to value destruction over time if they are not properly run.

The devil is in the detail, and cargo strategy is very important, as it will gauge their ability to cover multiple aspects of their global businesses, while maintaining financial discipline; it will also say a lot about their broader strategy – in this context, consider that all three carriers are at a very critical juncture at present.

Similarities, stock performance

Financially, these three companies are not dissimilar, although Delta is the strongest, and its shares command a 20% premium over those of its rivals, based on their forward core cash flow multiples.

Over the last two couple of years their performances read:
Delta’s stock price: +120%
AA’s stock price: +127%
UAL’s stock price: +73%

The problem is that all these stocks peaked in early January, and ever since they have recorded the following performances:
Delta’s stock price: -6%
AA’s stock price: -20%
UAL’s stock price: -12%

Unsurprisingly, volatility has come back with a vengeance on the back of increased domestic competition that has brought downwards pressure on revenue. Hence, quite simply, their stocks have not bottomed out based on fundaments, core margins, cash flows, relative valuations, leverage and a zillion of other factors, including a top-down approach, according to which Brent will fast appreciate in the second half of 2015, in my view.

Cargo performance

American, in particular, drew the attention of our team in July when it announced a new European sales focus.

The group is set to up competition in European skies – where competition is not needed at all. But it makes some sense, in the light of its recent performance. For the three months ended 30 June, its cargo unit reported revenues of $194m, down 12% year-on-year, out of almost $11bn of group sales for the quarter.

Delta’s quarterly results similarly showed $200m of cargo revenues, down 10% year-on-year, out of $10bn of group revenue for the three months ended 30 June. The annualised figure for its cargo top-line, based on revenues of $424m for the first six-months of 2015 (1H 14: $447m), is about $1.7bn for the year, which stands at about 50% and 63% of Air France’s and Lufthansa’s cargo revenues, respectively.

United Cargo, which claims now to have captured the top position in both cargo volume and revenue among US passenger carriers, is nevertheless a similar in size to its domestic rivals. Its revenues declined more slowly, though, at -1.3% over the three months ended 30 June, but they were up 7% to $471m in the first half of the year.

If the Americans are serious about cargo, European expansion could come from deeper ties with their ailing German and French rivals – neither of which has much cash, but both have precious traffic rights. Of course, the hot topic right now is expansion abroad in their core passenger businesses, not cargo.

Far East

At the end of July, Delta secured a 3.55% stake in China Eastern Airlines, “a move that would make it the first US carrier to own part of a Chinese airline,” news agency Reuters pointed out. “Delta’s purchase challenges rival United Continental, the leading US airline for service to China,” it added. United told The Loadstar that its leadership position there was a “key to our growth plans”.

But there are a few reasons why these carriers would do well to pay attention to their home markets and their cargo operations before making a foray abroad. In early July, United estimated that “passenger revenue per mile, a key benchmark, fell between 5.25-5.75% in the second quarter, consistent with analyst expectations,” according to AFP.

While disappointing “versus earlier quarter hopes, it did not deteriorate more than expected, said Barclays,” AFP added. At the time, American also trimmed its forecast “for adding seat capacity in 2015 up 1%, down from the 2% growth previously planned (…) the move is seen as likely to promote higher seat prices.”

In mid-July, Delta’s boss said that the group planned to cancel orders for 60 new planes from Boeing and Embraer after pilots voted against a new multi-year contract. Earlier this week, Delta said that passenger unit revenues in July dropped 3% on a comparable basis – a strong dollar, lower surcharges in international markets and excess seats weighed down its performance.

On top of all this, about a month ago the US Justice Department announced an investigation over “possible unlawful coordination” concerning all three carries, news of which pushed down the shares of all the major US players in the industry.

So, there are bigger issues than cargo and Cecil the lion, of course, but there may be soon more than pride at stake if core operating cash flows deteriorate fast and hefty fines hit. Then, analysts and investors will want to know the full details of every single line of business, particularly those – such as cargo – that are unlikely to make their cost of capital.