Unit Revenues Expected To Turnaround In Q4’16 For American Airlines, Costs To Weigh Down Earnings

American Airlines (NYSE:AAL) is slated to release its quarterly and full year earnings on the 27th of January, 2017. Although the carrier’s revenues fell slightly and earnings deteriorated in the third quarter results, American’s stock price was seen trending upwards afterwards. This is likely attributable to the company beating the consensus and showcasing better than expected performance in unit revenues. In the upcoming quarterly results, we expect the company to grow its revenues at a moderate pace due to disciplined capacity growth and a jump in yields. However, the bottom line may continue to suffer due to higher unit costs. In the following article we discuss some of the trends which are expected to be seen in the upcoming quarterly results.

Key Trends:

• American Airlines has consistently improved its unit revenues in the year 2016. Starting with a decline of -7.5% in Q1’16, the company improved its performance to -3.3% in Q3’16. This arrest in the fall in unit revenues can be understood by the company’s decision to cut capacity. The carrier may become the first in the year 2016 to show a turnaround in its PRASM numbers. It has revised its guidance for the final quarter of the year from a decline of (1%)-1% to a likely increase in the range of 0%-2%. This is attributable to the capacity discipline the company has been practicing on international routes and the improvement being seen in yields, especially Latin America.

• The company’s full year system-wide capacity should come in the range of its guidance of approximately 2%. To this end, American decided to keep its capacity growth almost flat in the quarter. However, the continuous decline in its occupancy factor indicates that the carrier is still unable to fully utilize its existing capacity. Consequently, the moderation in capacity will support the airline’s bottom line, partially offsetting the negative impact of higher fuel cost and operating expenses excluding fuel. Going forward, the company emphasized that it will continue to maintain capacity discipline in FY 2017, such that the growth is limited to a percentage point. This is likely an effort to control the negative headwinds its unit revenues are suffering from, especially in the Pacific and Atlantic, and manage the excess capacity that has been built into the system.

• We have recently seen some recovery in oil prices, owing to the OPEC countries’ decision to restrict their combined oil output to 1.2 million barrels of oil per day (Mbpd) over the coming months. In addition to this, the Non-OPEC members, such as Russia, also supported the OPEC’s move by offering to bring down their production by roughly 600,000 barrels of oil per day. In response to the news, crude oil prices shot up by around 10% over the last one month of the year, reinforcing to investors that the commodity markets are on the path of recovery. The increase is likely to impact the airline’s fuel expenditure, but not by much, as the prices continue to be much lower than the historical $100 per barrel.

• The company is concentrating on cutting its non-fuel expenditure by promoting operational expertise, to offset higher fuel costs. However, after being capped in the first two quarters, American’s unit costs began increasing in the third quarter. The increase in unit costs is mainly attributable to higher salaries and maintenance expenses incurred in the quarter. The trend is expected to worsen in the fourth quarter. Unit costs, excluding fuel, are expected to grow at 8% – 10% y-o-y in the fourth quarter. Consequently, we can expect the operating margins to decline significantly.

• Accordingly, American’s management expects its pre-tax margin for the fourth quarter to be in the high single digits, that is, 7%-9%. Given that American doesn’t hedge its fuel consumption, the coming year may be a tough one for the company.

Have more questions about American Airlines (NYSE:AAL)? See the following links:

• How Did American Airlines Perform Operationally In December?
• What Does The Future Look Like At American Airlines?
• What Could Be The Potential Impact Of Multi-Fold Increase In Passenger Demand On Airlines?
• How Did American Airlines Perform Operationally In October?
• American Airlines Q3’16 Earnings Review: Unit Revenues Improve, But Costs Increase
• American Airlines Q3’16 Earnings Preview: Reduction In Capacity To Partially Offset Lower Unit Revenues
• Why Are Airline Manufacturers Witnessing A Slowdown In Commercial Orders?
• Air Traffic Under Closed Economic Policies Due To Hostile Situations: Downside Scenario
• Air Traffic Under Liberal Economic Policies: Upside Scenario
• How Will American Airlines Benefit From Its New Fleet Plan?
• What Are The Factors Behind Soaring Air Travel Growth?
• How Important Will American’s International Operations Be In 2020?
• How Will American Airlines’ Equity Value Move, If Crude Oil Prices Rebound To $100 Per Barrel By 2018?
• Why Are American Airlines’ Domestic Operations More Valuable Than Its International Operations?

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment and ask questions on the comment section, or email content@trefis.com

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis for American Airlines

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