American Airlines 2Q Preview: Earnings To Remain Strong Despite Decline In Revenue

American Airlines Group (NASDAQ: AAL) is scheduled to announce its first quarter operating results before the market opens on Friday, 24th July 2015((American Airlines To Announce Second Quarter Results, 13th July 2015,www.aa.com)). Defying its previous stance of maintaining capacity discipline, the world’s largest airline (by traffic) increased its system capacity during the quarter, leading to a sharp fall in its stock price as investors anticipated this move to lead to an excess supply of seats in the US market. While American’s major objective behind the capacity expansion was to defend its market share from the smaller and low cost carriers, it is likely to result in a significant drop in the airline’s unit revenues for the quarter. Thus, we expect the airline to witness a decline in its revenue, while it will continue to post a notable earnings growth on the back of fuel cost savings. Here’s a quick look at the key trends that we expect to see in American’s second quarter earnings release.

Source: Google Finance

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Capacity Additions Drag Down Unit Revenues

American Airlines had been facing a lot of pricing pressure due to the ongoing dispute between Southwest and Delta over subleasing of landing gates at the Dallas Love Field Airport. In addition, the airline has experienced stiff competition from smaller and low cost carriers such Southwest and JetBlue.  As a result, in order to protect its market share, American decided to change its previous stance of restraining capacity.

Thus, American reported a 2.4% increase in its capacity, leading to a 2.8% rise in its passenger traffic during the month of June((American Airlines Announces June Traffic Results, 10th July 2015, www.aa.com)). However, the airline expects this capacity increase to weigh heavily on its pricing, resulting in a 6%-8% decline((American Airlines’ Investor Update, 10th July 2015, www.aa.com)) in its unit revenue for the latest quarter. Accordingly, we forecast American to see a notable drop in its top line for the quarter. The market expects the airline to report second quarter revenue of $10.89 billion, a decline of over 4% on a year-on-year basis.

Fuel Cost Savings To Drive Margins  

According to the latest investor update, the airline expects its fuel price to average between $1.88 and $1.93 per gallon((American Airlines’ Investor Update, 10th July 2015, www.aa.com)), higher than the company’s guidance of $1.84-$1.89 per gallon((American Airlines’ Investor Update, 24th April 2015, www.aa.com)). However, since the airline has stopped hedging its fuel consumption post its merger with US Airways, we expect the airline to deliver a significant growth in its earnings, despite this revision. However, the impact of these fuel cost savings will be dampened by an increase of 2%-4% in its unit costs (excluding fuel and special items) in the last three months. Consequently, the airline now projects its operating margin to be in the range of 16% to 18% against its previous expectations of 18%-20% operating margin. The analysts expect American to earn a profit of $2.62 per share, more than double  the profit earned in the same quarter last year.

To summarize, while the decline in unit revenue is likely to pull down American’s second quarter revenues, we expect the airline to post an impressive growth in its quarterly earnings due to the lower fuel prices realized during the quarter.

Source: Google Finance

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