Aeromexico Struggles as Most North American Airlines Report Hefty Profits

Despite one of the more favorable macro environments for North American airlines in recent years, Aeromexico this week reported a fourth quarter operating loss of more than $46 million, blaming restructuring costs, a higher-than-expected fuel bill, and increased competitive capacity in domestic and U.S. markets for the disappointing result.

Excluding special items, the airline posted a tiny operating profit, of 0.6 percent, executives said Wednesday on their fourth quarter earnings call.

During the quarter, unit revenues held up reasonably well, up 6.5 percent-year-over year. But costs were an issue.

Aeromexico was more affected by higher fuel prices than U.S. airlines because it earns much of its revenue in Mexican pesos, but pays for fuel in U.S. dollars. The airline told investors its fourth quarter fuel price increased 28 percent, year-over-year. Part of the problem was the 4.4 percent depreciation of the Mexican peso against the dollar, the airline said.

Meanwhile, as costs rose, some key markets did not perform as well as expected. While long-haul route performance was acceptable, executives said, domestic and U.S. flights lagged. As a result, Aeromexico made changes to its fleet structure and capacity planning during the quarter.

Most notably, Aeromexico executives said they're trying to shrink the airline to better performance, noting they have removed three Embraer E170s and two Boeing 737-700s from operations. The company said it took a $19.8 million accounting charge from selling aircraft during the quarter.

As the short-haul fleet shrinks slightly, Aeromexico will reduce domestic capacity this year, executives said, while slightly increasing long-haul capacity.

In sum, the airline will have 0 percent capacity growth for 2019 — a big difference from last year, when it grew by 8.2 percent.

"For the rest of the year, we will continue to manage our capacity with strict discipline," CEO Andrés Conesa told analysts. 

Route Cuts

As it tries to improve profitability, the airline has cut flights to several U.S. cities, including Washington Dulles, Boston and Portland, Oregon, while reducing frequencies to other markets, executives said.

In 2016, the United States and Mexico renegotiated their air services agreement, liberalizing rules about what airlines could fly where. That led several airlines to expand U.S.-Mexico routes, and yields on many flights have deceased. (Both JetBlue Airways and Southwest Airlines, at first keen to expand to Mexico, have pulled back due to competitive pressures.)

"Open Skies [created] a significant amount of additional capacity, and as we have mentioned in previous calls, it wasn't profitable," Conesa said. "Some airlines, including us, are canceling flights."

Mexico also has too many airlines launching domestic flights, Aeromexico executives said, leading to similar problems. Several low-cost carriers are challenging Aeromexico, including Volaris and Interjet.

"What we have said consistently is at least in the domestic environment, we do see the overcapacity," chief revenue officer Anko van der Werff said. "Definitely international is working better at the moment."

Frequent Flyer Changes

Aeromexico executives also said they took a financial hit in the fourth quarter because they changed assumptions on how many frequent flyer miles would go unused — what the industry calls breakage.

Aeromexico is now betting more customers will redeem their miles, which could be costly to the airline. The company's CFO, Ricardo Sanchez Baker, tried to spin this as a positive, saying it means customers are now more engaged in the program. Long-term, executives said, this could lead to more revenue.

"A high breakage rate is a sign that the customers are not engaged with the loyalty program," he said. "They are not returning to use the points they have, and they are not necessarily generating a big business nor becoming losses. However, thanks to the improved customer proposition, more of our passengers are engaging with the program and redeeming their points."

Aeromexico said it took about a $30 million charge from this change.