JAL’s quest for survival a tale of pros and cons

Delta deal promises cost cuts; American offers smooth tieup

by and

Since news broke last week that Japan Airline Corp. is seeking a capital investment from a foreign airline, speculation has been rife over which one would make the best fit for the struggling carrier.

On Tuesday, JAL President Haruka Nishimatsu said the airline plans to ink a partnership agreement with either AMR Co.’s American Airlines or Delta Air Lines by mid-October.

Although no specifics of the negotiations have been disclosed, the pros and cons show there are risks in either deal.

Industry observers say a tieup with American Airlines would likely go more smoothly because both are members of the Oneworld alliance. Delta might be the better partner in terms of cutting management costs because the two airlines have many overlapping flights and would benefit by cutting some of them.

Makoto Murayama, a senior analyst at Nomura Securities Co., said that Northwest Airlines, which was just bought by Delta, has about 16,000 takeoff and landing slots annually at Narita International Airport, a hefty part of its Pacific operations. American only has about 3,600 slots at Narita.

In other words, Delta has more competing flights with JAL, which would give them more room to cut costs if they form an alliance.

“If the (airline industry) situation were more stable, two companies usually form a partnership to provide things that one does not have. It would be best to go with American if the company was doing well,” Murayama said.

But conditions are far from stable, and there are no simple fixes.

The airline industry is running into turbulence on a number of fronts, including volatile oil prices, the global recession and the swine flu outbreak. The International Air Transport Association revised its global financial forecast to predict that losses in the industry will reach $11 billion in 2009, instead of the $9 billion it previously projected.

Even Delta and American are reporting losses. In the April-June quarter, Delta posted a net $257 million in red ink, while AMR posted a net loss of $390 million.

Since 2007, JAL has been in streamlining mode. It has announced it will let more than 4,000 employees go and abolished unprofitable routes. While it managed to report a ¥16.9 billion net profit in the business year through March 2008, it stalled and dived to a ¥63 billion loss the following year. This year, JAL reported a ¥99 billion net loss in the April-June quarter.

The government is worried about the Japanese flag carrier’s survival and convened a panel to discuss reconstruction scenarios. JAL recently borrowed about ¥100 billion to stay afloat and reportedly will need to find an extra ¥150 billion later this year. A reconstruction plan submitted this week proposes cutting 6,800 employees by the end of fiscal 2011 and suspending 50 domestic and international routes.

With passenger demand declining overall recently, the industry has an overcapacity issue. From that perspective, it is important how much airlines can reduce their overlapping operational costs through code-sharing flights, Murayama said.

Takahiko Kishi, senior analyst at Mizuho Investors Securities, said that in terms of cutting costs, Delta is the better choice.

“Delta has many U.S.-Japan flights, so they can offer their services more economically if they code-share their flights with JAL,” he said.

One factor that may leave JAL hesitant to tie up with Delta is that they are in different worldwide alliances. Delta belongs to SkyTeam, whose members include Air France and Korean Air, and it would cost JAL tens of billions of yen to switch over its various operational systems, such as reservation codes, if it left Oneworld.

“While receiving tens of billions of yen from Delta, it would also cost some ¥10 billion for JAL (to switch alliances),” Kishi said.

For both American and Delta, the stakes are high.

If JAL decides to leave its current alliance, it would be a severe blow to American Air, Murayama said, because AA doesn’t serve as many Pacific routes as Delta’s Northwest. American is currently seen as competing well with Delta in the Pacific because of the alliance with JAL.

Delta meanwhile is hoping to gain a better competitive edge in the Pacific while cutting costs.

“I think JAL is in the middle of estimating who will be better for itself, considering the cost-cutting and effect of the partnership,” said Mizuho’s Kishi.