American Airlines Pushes Capacity Constraints

The CEO of the world's largest airline is trying to exert leadership in his notoriously undisciplined industry.

In fact, Gerard Arpey, CEO of American Airlines parent AMR(AMR:NYSE), is trying to lead by example. Arpey said last week that in 2007 American will cut overall capacity by 1%, with a somewhat larger decrease in domestic capacity.

"There is still a lot of destructive competition, particularly in the U.S. markets today, and particularly with flow traffic," Arpey said, on a conference call. "That's why we remain very cautious in terms of our own capacity, and I think macroeconomics suggest that the industry should feel the same way."

Experts are divided on whether Arpey can succeed in influencing other airlines. "It's impossible," says consultant Scott Hamilton, who publishes an online newsletter about Airbus and Boeing. "The other airlines are going to do what they can in their own best interest, not what is in the best interest of the industry as a whole."

But consultant Dan Kasper of LECG in Cambridge, Mass., said Arpey's words may have an impact. "This will make it a little bit easier for carriers sitting on the fence to say that 'If I am more cautious about adding capacity, I don't have to worry about losing market share to American,'" Kasper says.

American has often assumed a role as the industry's leader, even before it became the biggest carrier upon acquiring TWA in 2001. Former CEO Robert Crandall was an outspoken chieftain in the mid-1990s. Now Arpey is speaking out, not only as American CEO since 2003 but also as chairman of the board of the Air Transport Association, the industry's principal trade group.

Arpey has an ally in Doug Parker, CEO of US Airways(LCC:NYSE), who has said repeatedly that reduced capacity is the primary source of the current industry recovery. "It's not great management," Parker said at a July earnings conference. "It's because a bunch of seats went away. [And] as seats have gone away, you have seen the ability to raise fares."

The other legacies' CEOs are busy doing their own thing. United(UAUA:NASDAQ) CEO Glenn Tilton takes every opportunity to speak out for his cause: industry consolidation, hopefully involving United. CEOs at Delta(DALRQ:BB) and Northwest(NWACQ:BB) are fixing their carriers in bankruptcy, with Gerald Grinstein remaking Delta into a major international carrier.

Then there is Continental(CAL:NYSE). Alone among the legacy carriers, Continental is growing rapidly, with consolidated capacity rising about 9% in 2006 and 4% in 2007. Nevertheless, on Continental's conference call last week, company executives expressed concern that declining fuel prices could lead competitors to slow the pace at which older aircraft are being retired. As a result, "Lower fuel prices are not a panacea," said President Jeff Smisek.

Airlines sometimes have a double standard, notes Kasper: "They say, 'The capacity that other people add is bad, but mine is justified.'"

Of course, while most legacy carriers have been shrinking capacity, low-cost carriers have been growing. At Southwest(LUV:NYSE), which has a fleet of 468 Boeing 737s, capacity growth will be a whopping 8.8% this year and 7% to 8% in 2007. As a whole for 2006, the industry's domestic capacity is down 1.3% while U.S. carriers' international capacity rose 4.7%, according to the ATA.

CreditSights analyst Roger King says that even if legacy carriers wanted to order new aircraft, they can't because of backlogs at Boeing(BA:NYSE) and Airbus. "There isn't much capacity coming into the system, and I think that will continue for the next couple of years, until the Boeing 787 comes on line," he says. "And sometime after that, the Airbus 380 and 350 will come."

To an extent, Arpey's advocacy is born of necessity, adds Hamlton. "If American turned around tomorrow and said 'we want 300 (narrow body) airplanes,' neither Boeing nor Airbus could deliver before 2010," he says. "American could bring in airplanes from the desert, but they are taking the position that for their own financial recovery, keeping control on capacity is the best way to achieve that."

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