As American Airlines’ (PINK:AAMRQ) gears up to implement massive cost-cutting plans aimed at helping it exit bankruptcy as a standalone carrier, engine-related emergencies on two separate flights in 10 days could subject those plans to closer scrutiny.
Dallas-bound American Flight 1349, a twinjet MD-80 produced before Boeing (NYSE:BA) acquired McDonnell Douglas in 1997, experienced an engine problem shortly after takeoff from Omaha Tuesday morning. The aircraft returned to Omaha’s Eppley Field and landed safely.
Tuesday’s incident, which like all such events will be investigated by the National Transportation Safety Board (NTSB), comes just 10 days after another American MD-80, en route from Dallas to Seattle, was forced to make an emergency landing due to engine trouble. That flight also landed safely, after the flight crew shut down the engine and diverted to Boise, Idaho.
While mechanical incidents like these happen to all carriers from time to time, federal regulators take them very seriously. There are three reasons why these incidents are extremely troublesome for American right now:
1. The airline needs to slash costs — and jobs. In an effort to spurn unwanted advances from potential suitors such as US Airways (NYSE:LCC), Delta (NYSE:DAL) or others, CEO Tom Horton last week announced plans to slash 13,000 jobs and some $2 billion in annual labor and benefit costs. American will cut some 4,600 mechanics and close its major maintenance hub in Fort Worth, Tex., which handles most maintenance on its Boeing 767s and 777s. That means contracting out more maintenance work — perhaps to facilities outside the U.S. that the Transport Workers Union argues could be difficult for federal safety inspectors to monitor. Horton contends that there is a “broad and deep marketplace for heavy maintenance on wide-body airplanes” and that “they can be maintained anywhere.”
2. American already is under aggressive safety supervision. When an airline files for bankruptcy, federal regulators typically increase safety inspections — particularly those that relate to maintenance programs and personnel, reporting systems, or records and management. American has been under this stepped-up protocol since the company filed for bankruptcy on Nov. 29. U.S. carriers traditionally have had a strong safety record while in bankruptcy. However, American’s two incidents in less than two weeks will no doubt pull regulators’ focus.
3. The FAA already was focused on MD-80 maintenance issues. Just 18 months ago, the FAA levied a record $24.2 million fine on American for flying 286 MD-80 jets without making critical upgrades to wiring in the landing-gear compartment that potentially could have caused an explosion in nearby fuel tanks. American is still fighting the massive civil penalty stemming from those violations four years ago, which at the time prompted the FAA to ground American’s entire MD-80 fleet for four days.
Still, American Airlines has not suddenly become less safe since it filed for bankruptcy. The safety record of U.S. airlines in Chapter 11 is in fact slightly better than average because of the enhanced oversight. But in cases like these, federal regulators are prone to act on the side of caution and could take an even closer look at American’s fleet-maintenance plans in the days and weeks to come.
The timing of these two MD-80 incidents is a bigger issue for American’s future plans to move more of its maintenance work to contractors, particularly those with non-U.S. facilities. Lowering maintenance outlays is a critical part of Horton’s cost-cutting strategy — one that is absolutely necessary if the carrier is to have any realistic shot of exiting bankruptcy as a standalone carrier.
Horton has said this week that not only will American emerge from bankruptcy as a standalone carrier, it could even look to take over another airline.
The stock currently is trading around 65 cents, up substantially from its close of 20 cents after the bankruptcy filing, but nowhere near its high of $7.60 this time last year. The airline has a market cap of just $217.3 million and a one-year return of -91%.
Action to Take: American will not pull out of its tailspin quickly or easily. In addition to the maintenance-outsourcing issue, cutting jobs and terminating pensions will exacerbate tension between labor and management in the short term. American did get some good news — slightly more passengers flew on the airline last month than in January 2011 — despite the fact that the carrier is in bankruptcy.
Small-cap stocks are a risky business at the best of times and far more so in the case of a legacy airline that is forced to reinvent itself on the fly while in bankruptcy. Look for the stock to bounce around between 35 cents and 70 cents over the next few weeks as the carrier’s revival plans continue to unfold.
As of this writing, Susan J. Aluise did not hold a position in any of the stocks named here.