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Was Doug Parker’s $5 billion ‘average’ earnings prediction a mistake?

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Last year, American Airlines CEO Doug Parker repeatedly made a bold assertion in a number of public forums: American going forward would average an annual pre-tax profit of $5 billion. An off year may produce a pre-tax profit closer to $3 billion, while a banner year would produce a pre-tax profit of around $7 billion, he explained. This would be a level of earnings “no one has ever fathomed before” for an airline, Parker acknowledged.

The investment community, in particular, has seized on Parker’s $3 billion-$7 billion range for yearly pre-tax earnings and his $5 billion “average” prediction. And that has caused a bit of a problem for the American CEO. American’s pre-tax profit for 2017 was $3.8 billion and, with fuel prices soaring, will likely be less than that in 2018—probably hovering right around Parker’s $3 billion “off-year” floor. That means American’s first two annual financial results following Parker’s $3 billion-$7 billion assertion will end up at the low end of the range.

And the company will need exceptionally strong years in 2019 and 2020 to hit a $5 billion average for the first four years after Parker made the $5 billion average pre-tax profit claim.

Does Parker regret putting the $3 billion-$7 billion range out there? Was it a mistake?

During American’s first-quarter earnings call, analysts repeatedly peppered Parker with questions about the $5 billion average.

Parker estimates fuel costs will add $2 billion to American’s annual expense ledger in 2018 compared to 2017, keeping this year’s pre-tax profit well below $5 billion. Parker did not recant his previous predictions, instead—as he almost always does—pushing Wall Street to take the long-term view.

“At this level of fuel price, I’m highly confident American can produce $5 billion in pre-tax earnings. [But] not right now,” he explained. “This fuel price increase happened very quickly. Since last summer, oil prices have increased 60%. That’s a big increase in a short period of time … That kind of increase is going to have an impact on airline earnings … Fuel prices have risen very quickly and it takes time to adapt. I view that as a near-term problem, not a long-term problem. The industry can handle it long term, but not immediately.”

Parker reiterated that “we have an airline that can make $5 billion in pre-tax earnings at $75 a barrel oil” if given the time to adjust.

Two near-term issues for American: 1) It needs to raise fares to make up for the fuel price rise, but it is not the fare pace-setter on most of its routes, particularly domestically, where ULCCs and, to a lesser extent, Southwest Airlines generally set fare levels. Interestingly, Ryanair CEO Michael O’Leary said May 21: “Air fares tend to follow oil prices, but with a lag of up to 12 months before higher oil prices feed through to higher air fares.” 2) Parker brought with him from US Airways a strongly anti-fuel hedging philosophy. American doesn’t hedge, meaning it reaps big rewards when fuel prices drop, but suffers all the pain when fuel prices rise.

So, the reality is American is probably going to “average” $3 billion-$4 billion in pre-tax income over 2017-2019. If Parker had not said anything about a $5 billion average and a $3 billion-$7 billion range, this would be lauded as excellent results despite some strong cost headwinds from labor and fuel. It is certainly far better than US airlines have done through most of their history. But since Parker repeatedly and vocally touted the $5 billion average, he put a bright marker out there. And it will be easy (and not entirely inaccurate) for reluctant investors to say, “American is performing below average.”

I’d be surprised if Parker backs away from what he has previously said. He may clarify that the $5 billion average is a long-term average over, say, 10 years. Critics will point out that fuel cost spikes and other extraneous factors that impact the bottom line can come up quickly and unexpectedly, and Parker should have factored that in. This is a big reason why airlines have historically struggled financially.

Parker, perhaps the biggest proponent of the school of thought that this time really is different and US airlines are now managed smartly and in a way what will generate profits year after year, may have been setting an ambitious goal for his own team. In other words, don’t settle for just being profitable; strive for profits that make American comparable to other major corporations, not just better than other airlines and certainly not just better than past airline industry performance—which, to say the least, would not be very hard to beat.

That’s a laudable goal. But until American actually achieves the $5 billion average, Parker will have to answer questions about it on every earnings call going forward and other forums where he discusses American’s financial performance.

Aaron Karp/Aviation Daily, aaron.karp@informa.com

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