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The earnings season for U.S. airlines is just around the corner, with Southwest Airlines (LUV) having already reported its performance for its second quarter, while Delta Airlines (DAL) and U.S. Airways (LCC) are scheduled to repor theirs today. United ContinentalHoldings (UAL) will be reporting tomorrow.

Airline traffic growth is highly correlated to GDP growth, as illustrated by the graph below. The U.S. economy is showing no signs of a recovery, which is evident after looking at more and more economic data, like the recent retail sales and jobs data, coming out below expectations. The Federal Reserve, besides its previous efforts (Operation Twist and maturity extension program), is looking into the possibilities to set tables for further easing. The sluggish U.S. economy is adversely affecting U.S. airlines.
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Source: Boeing

However, on the positive side, oil prices, which amount to be the single largest expense for U.S. airlines, have declined since the beginning of the year's second quarter; but only a few airlines will benefit from this decline. Jet fuel prices during the month of May alone fell by 8%. The drop was 10% in June 2012. Typically, fuel costs account for around a third of airline expenses. However, since most have hedged this expense, a decline in fuel prices will lead to hedging losses for these airlines.


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Source: indexmundi

Despite the headwinds from Europe, hedging losses and the sluggish U.S. economy, the U.S. Airlines Industry has shown tremendous gains since the beginning of the year. The airlines ETF (FAA) is up 7.5%, while airlines are currently reaping benefits of the prevailing peak summer season.

Delta Airlines

DAL, the second largest airlines company, is scheduled to report its second quarter performance today (July 25, 2012). The Whisper number for Delta Airlines is 5 cents below the consensus analyst estimates of $0.68. This is 47% above what it earned last year. Analysts believe the company will be able to generate a turnover of $9.68b. The airline has a history of negative surprises with an average surprise of -14%. The implied one day move for the stock after its earnings release is 8%. The direction of the move depends on whether the stock misses or beats estimates. On the last three positive surprises, the stock appreciated by 9.5% in value in a single day. The stock fell by 4.5% one day after its earnings missed estimates for the last five times. One week after the company beat estimates, on average the stock appreciated by 14%; while it depreciated by 4.2% if it missed analyst estimates. The company has an aggressive policy to hedge its fuel costs, and in this regard it has struck a $150mn deal to purchase an oil refinery, which is expected to start operations by the end of the third quarter.

United Continental Holdings

The company is expected to report its results for the second quarter by July 26, 2012. On a turnover of $10.04b, analysts have consensus earnings per share estimates of $1.7. The stock has a surprise-to-price change correlation of 0.54, meaning any surprises in earnings that it reports will move the stock price. The company has a history of beating analyst estimates with an average surprise of 9.1%. The stock on average appreciated by 2% in value one day after it beats estimates. In one week's time, the stock appreciated by 2.5%.

The company guided down its second quarter earnings forecasts by 2%, owing largely to the revenue adjustment due to which it overstated its RASM growth by 1 percentage point. It seems the integration of United with Continental airlines is slower than expected. The company disclosed it would book $206mn and $137mn in special charges and integration expense, respectively. Investors need to be on the lookout for how United resolves the join pilot contracts issue, which could affect the company's operations in the coming quarters.

U.S. Airways

U.S. Airways, America's fifth largest airline, is also scheduled to report its second quarter results today (July 25, 2012). The consensus analyst estimate for the company's top line is $3.75b, and it is anticipated to earn $1.56 per share. The company has a history of beating estimates as far as its EPS is concerned. Average earnings surprises have been around 28%. The stock appreciated by 5% and 8% one day and one week after it beat estimates, respectively.

U.S. Airways, as we predicted in one of our previous reports, will be one of the major beneficiaries of the decline in oil prices, since it does not hedge its fuel needs. The company is already celebrating the decline in fuel prices, as demonstrated by its YTD performance of 129%. The company also reported its mainline revenue passenger miles for the month of June this year at $5.8b, up by 1.7% when compared to June last year. These are the reasons why we maintain our bullish stance on the company.

Valuations

LCC is trading at an earnings multiple of 10x, which is at a 53% premium and 76% discount when compared to Delta and United Airlines.

Source: Airlines Earnings Preview