21 Oct

Can American’s Q3 Earnings Grow despite MAX Woes?

WRITTEN BY Anirudha Bhagat

American Airlines (AAL) plans to report its Q3 earnings results on October 24. Wall Street expectations indicate the company’s top- and bottom-line results could mark significant YoY (year-over-year) improvement despite Boeing’s (BA) 737 MAX woes. Analysts expect American Q3 earnings to rise 23.7% YoY to $1.40 per share.

Wall Street’s earnings growth projections suggest a sharp improvement from its results in the first half of 2019. In the first quarter, the company’s EPS plunged 30.7% YoY, while in the second quarter, it grew 11.7% YoY.

Increased revenues and lower fuel costs could drive American Q3 earnings higher. For the third quarter, analysts forecast American’s revenues to grow 3.4% YoY to $11.9 billion. Notably, analysts’ Q3 top-line growth projection is higher than the company’s preceding two quarters. The airline’s YoY revenue growths for the first and second quarters have remained below 3%.

American Airlines also believes that healthy passenger demand and yield could drive its unit revenues higher in the third quarter. During the October 9 investor update, the company updated its unit revenue growth guidance for the third quarter. The company now anticipates unit revenues to increase 1.5%–2.5%, instead of the previous projection of 1%–3%. Although the company narrowed its guidance range, the updated outlook remains the same at the midpoint.

Additionally, we believe that higher ticket prices could boost American Airlines’ top and bottom-line results in the third quarter. According to a June 13 JPMorgan Chase report, the company increased its passenger fares twice in the first half of 2019.

MAX crisis to hurt American’s Q3 earnings

The prolonged grounding of Boeing’s 737 MAX jets should continue to impact American Airlines’ financials. The 737 MAX fleet has been grounded since mid-March following two deadly accidents within five months. The flying ban on the MAX has caused thousands of flight cancellations for American Airlines.

American Airlines has a total of 24 Boeing MAX aircraft. The grounding of these planes caused 115 daily flight cancellations for the company. During the October 9 investor update, the airline revealed that it experienced 9,475 flight cancellations in the third quarter due to the MAX grounding.

The company also expects that the flight cancellations would negatively impact its third-quarter pretax income by $140 million. However, the airline has managed to reduce its operating loss from the MAX grounding in the third quarter. In the second quarter, it recorded an impact of -$175 million due to MAX flight cancellations.

The grounding of the MAX fleet would reduce AAL’s total seating capacity, thereby increasing its unit cost. For the third quarter, American Airlines forecast its ex-fuel unit cost to rise 4%–6% YoY.

American Airlines has company in grappling with the MAX crisis. Southwest Airlines (LUV) and United Airlines are also feeling the pinch of the MAX grounding. Southwest Airlines, which owns 34 MAX planes, is facing approximately 200 daily flight cancellations. In the second quarter, the flight cancellations impacted its pretax income by -$175 million.

Another US major carrier, United Airlines (UAL) has 24 MAX aircraft. The company has managed to fill the MAX flying schedule through its older aircraft. However, the use of larger and less fuel-efficient jets is increasing its operating expenses. The company’s ex-fuel costs increased by 2.1% YoY in the third quarter.

Low fuel costs to boost margins

In our view, lower fuel costs could more than offset the negative impact of higher ex-fuel costs on American Airlines’ Q3 margins. Notably, crude oil prices were more economical in Q3 2019 compared to Q3 2018. The average WTI prices were $56 in the last quarter, about 19% lower than $69 in Q3 2018.

For airlines, fuel accounts for nearly one-fourth of their overall operating expenses. Therefore, the drastic decline in oil prices would have undoubtedly benefited American Airlines’ third-quarter bottom-line results.

During its October 9 investor update, American Airlines lowered the average fuel cost forecast for the third quarter to $2.03–$2.08 from $2.05–$2.10 per gallon, which it previously forecast. The updated guidance range is 10%–12% lower than its Q3 2018 fuel cost per gallon of $2.30.

The company anticipates higher revenues, increased fares, and lower fuel costs to boost its third-quarter pretax margin. So, it has raised the upper-end pretax margin guidance range for the quarter. The company now expects a pretax margin of 6.5%–7.5%, compared with the previous guidance range of 5.5%–7.5%.

Analysts’ stance ahead of Q3 earnings

Marred by the ongoing Boeing MAX crisis and labor disputes, American Airlines stock has lost 12.1% of its market value YTD (year-to-date). At last Friday’s closing price of $28.22, the stock currently trades near its five-year low of $24.23, which it reached on August 28.

AAL stock is down over 52% from its five-year high of $59.08 attained on January 16, 2018. The stock is also down over 30% from the 52-week high of $40.58 reached on December 3, 2018.

Analysts have also changed their stances on American Airlines stock as the year has progressed. In the beginning, analysts were optimistic about the airline’s growth prospects. However, the MAX problem and labor disputes have made analysts increasingly cautious about the stock.

In January, about 74% of the 19 analysts covering AAL stock a bullish stance on American Airlines stock. The remaining 26% recommends holding it, and none of the analysts were bearish on the stock. However, that perspective has changed significantly due to the challenges the company is currently facing.

On October 21, two of the 20 analysts turned bearish on the stock. Now, the proportion of bullish analysts has dropped to 60% from 74% in January. About 30% of the analysts have a neutral view, while the remaining 10% have a bearish stance. Their average target price of $44.94 in January has also fallen 18% to $36.94.

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