American Airlines’ Stock Down, Despite Improvement In Unit Revenues In Q4’16

American Airlines (NASDAQ:AAL), announced its fourth quarter and full year earnings on 27th January, 2017, beating the consensus for both revenues and EPS. However, the carrier’s stock price was seen tumbling post the earnings release. The descent in the stock price is likely due to the decline in earnings per share in Q4’16 due to the increasing labor costs for the airline. That said, the company became the first major airline in Q4’16, after a spell of almost two years, to turnaround its unit revenues to positive. Consequently, the company also saw a modest increase in revenues.

To breakdown the improvement in top line, we focus on three key metrics: capacity, unit revenues, and load factor. The company practiced strict capacity discipline, restricting the average seat miles growth to barely 1.7% in the year 2016 and 0.4% Q4’16. The restriction was undertaken to arrest the fall being seen in unit revenues, given the industry dynamics and yield pressures. American’s unit revenues improved significantly in the quarter, turning positive at 0.2%. This is attributable to the positive passenger yields seen in Latin America due to the improvement in Brazil’s economy, and significant advancements in domestic markets. At a growth of 10.2% y-o-y in Q4’16, Latin America was the best performing region for the company, with the domestic U.S. market close behind at 0.8%. In contrast, Pacific and Atlantic markets continued to weigh heavily on the company, with declines of -4.9% y-o-y and -7.7%, respectively. The main reason for continued pressure in these markets is the capacity added in the region by low cost carriers and the strength of the dollar. The strength of the dollar versus the pound, as far as transatlantic markets are concerned, is a huge negative for American as half of its transatlantic capacity is in the U.K.

Furthermore, capacity restriction was essential to counter the declining load factor or occupancy rate (indicating the over capacity built in the system). As a result of the moderation in capacity, American Airlines was able to turnaround its unit revenues in Q4’16 (+0.2% y-o-y). With a confluence of these three factors, American’s revenues saw a rise of 2% in the quarter, putting an end to the continued downtrend seen in consecutive quarters.

On the expense side, the significant increase in unit costs (+8.5% y-o-y) more than offset the rise in revenues, causing operating income to fall by over 28 percentage points. The increase seen in operating expenses is primarily attributable to the airline’s new labor contract, which has resulted in higher wages and profit sharing plan, and the higher maintenance expenditure in the quarter. Further, due to the higher tax liability in the quarter, its earnings per share came in much lower on a comparable basis.

The company returned approximately $606 million back to its equity owners in the quarter in the form of share buybacks ($554 million) and dividend payments, providing value to the shareholders. The company has completed its $2 billion share repurchase program authorized in April 2016. Going forward, it will be buying back shares under the newly authorized $2 billion share repurchase, approved in January 2017, due for completion by the end of 2018.

Going Forward

Going forward, American Airlines non-fuel costs are expected to increase by as much as 8%-10% in the first quarter of the year 2017, as the full impact of the labor agreement starts being felt. This, together with increasing oil prices, will lower the company’s pre-tax margins consequently. However, through the course of the year 2017, the non -fuel costs are expected to normalize, up only 4%. The company will keep restricting its capacity in order to grow unit revenues. While the system wide capacity is expected to be down 2% in Q1’17, it is expected to rise 1% for the full year 2017. Furthermore, most of this increase is expected in the Pacific region due to the addition of new markets in the area and upgauging program it carried out. On the other hand, domestically, capacity is expected to stay flat as the increase in seats offsets the impact of reduced departures. As a result of the capacity discipline, the company is confident to see an upward trend in PRASM for the rest of the year.

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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