American & United Plan To Add Capacity As Solid Demand & Lower Fuel Prices Lift Their Q3 Results

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American Airlines (NASDAQ:AAL) and United Continental (NYSE:UAL) – the two largest U.S. carriers by passenger traffic – plan to increase their flying capacity in the fourth quarter as solid demand for air travel lifted their third quarter results. The third quarter results of these carriers also received a boost from lower jet fuel prices, as global crude oil prices dipped during the quarter. We figure this growth oriented capacity stance and lower global crude oil prices will help lift results of both American and United in the coming quarters as long as demand for air travel keeps growing. Additionally, in our opinion, American and United are adding capacity to their networks in a disciplined manner, which is essential for the airline industry to remain profitable as a whole. Read here to understand why airlines need to add capacity with restraint to maintain overall industry profitability.

American’s Q3 Earning Analysis

American reported a profit (excluding special items) of $1.2 billion in the third quarter, up nearly 60% from the same period last year. [1] In our view, this solid profit performance from the carrier reflects gains from the US Airways merger, which has expanded American’s network, passenger traffic and income. This solid third quarter performance comes on the back of equally good results in the first two quarters of 2014. Steady demand for air travel in both domestic and many international markets has played a key role in enabling American to grow its profit so far this year.

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In addition, lower jet fuel prices during the third quarter lowered American’s fuel costs, which constitute the single largest cost item for an airline accounting for nearly one-third of total operating costs. This tailwind from lower fuel costs in the third quarter boosted American’s profit. The carrier also grew its top line on gains from from capacity expansion.

Looking ahead, American plans to increase its flying capacity by about 2% on a year-over-year basis in the fourth quarter. The carrier also anticipates to maintain a healthy pre-tax margin of about 10-12% in the fourth quarter. [2] In all, American looks set to post a highly profitable 2014 after spending the past few years in bankruptcy.

We currently have a stock price estimate of $40 for American, approximately in line with its current market price.

See our complete analysis of American here

United’s Q3 Earning Analysis

Separately, United carried forward its solid second quarter performance in the third quarter reporting a profit of $1.1 billion excluding special items. [3] The carrier started 2014 with a huge loss but quickly improved its revenue performance by restructuring its Pacific network. The carrier also undertook several cost cutbacks, which have controlled growth in its non-fuel costs. Through these two measures, United was able to lift its profit performance in the second and third quarters.

Additionally, United’s fuel costs also declined in the third quarter, boosting its profit. The decline in global crude oil prices has been considerable as overall fuel costs for both United and American fell despite both these carriers adding capacity.

Looking ahead, we figure as Southwest, Delta, Alaska and American have, United could begin paying dividend to its shareholders if it is able to retain this solid profit performance in coming quarters. The carrier has been able to control growth in its non-fuel costs, especially maintenance and distribution costs. Fuel costs are also likely to remain suppressed due to softness in global crude oil prices. So, if the demand environment remains strong and United adds capacity strategically to take advantage of this growing demand, then chances of United maintaining its strong profit performance in the coming quarters are high. So, we could see United initiating dividend payments to its shareholders in the coming months.

We currently have a stock price estimate of $49.50 for United, approximately 5% below its current market price.

See our complete analysis of United here

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Notes:
  1. American’s 2014 Q3 earnings form 8-K, October 23 2014, www.aa.com []
  2. American’s investor update, October 23 2014, www.aa.com []
  3. United’s 2014 Q3 earnings form 8-K, October 23 2014, www.unitedcontinentalholdings.com []