Possible Earning Miss For U.S. Airlines

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Includes: AAL, DAL, UAL
by: Bryan Scott

Summary

Large, unexpected increase in jet fuel is driving increased costs.

Company guidance and street expectations are still behind the curve.

Unhedged mainline airlines (AAL, DAL, UAL) are particularly exposed.

American Airlines (AAL), Delta Air Lines (DAL), and United Airlines (UAL) have all issued guidance for Q2 2018 earnings in April. Then, at the beginning of June, Delta revised its Q2 forecast in large part due to the increase in fuel prices. Since that revision, fuel prices have continued to be elevated for the rest of the quarter. Therefore, I will review the current guidance for each company, compared with fuel spot prices, and then determine the expected impact of higher fuel prices on Q2 earnings.

Background

For this analysis, I first determined the relationship between spot prices (as reported by EIA) and the economic cost of fuel as reported by the airlines in the past year. Based upon this analysis, the fuel cost reported by the airlines is about $0.20-0.25 above the spot price. Then, for each airline, I determine the impact by comparing the reported guidance on fuel costs to the actual spot fuel prices and the estimated fuel consumption by the quarter. The spot prices for Q2 2018 have averaged approximately $2.12 per gallon, based upon EIA reported jet fuel spot prices.

Since these airlines have specifically stated that they do not hedge their fuel consumption, the impact of changes in spot prices drops straight to the bottom line in earnings.

Each airline's fuel impact on estimated earnings is noted below.

American Airlines

Screen Shot 2018-06-30 at 8.15.21 PM.png

Source: American Airlines IR Guidance from April 26, 2018

Based upon the guidance and actual spot prices, we can calculate the impact of fuel prices on Q2 earnings for American Airlines:

Screen Shot 2018-06-30 at 10.45.02 PM.png

Source: Author's own calculations based upon American Airlines IR releases and EIA spot fuel prices

As you can see from the chart, jet fuel prices (as paid by American Airlines) were likely about $0.14 higher per gallon than initially projected a few months ago by the airline in its guidance. This increase in jet fuel prices would result in a decrease in earnings of about $0.34/share from earlier projections. Since pricing actions take 6-12 months to make up for increased fuel costs, a large portion of the increase in fuel prices will fall straight to the bottom line. The current earnings estimates have decreased in the past four weeks due to the rise in jet fuel prices, but there is a significant risk that the impact of fuel price increases is still not fully reflected in earnings estimates for Q2 2018. Current earnings estimates for Q2 are $1.60-1.85, with a mean of $1.69/share (per Marketwatch as of 7/2/2018). Even though these have decreased recently, I would not be surprised by an earnings miss of at least $.15/share (mean earnings expectation of $1.54/share, lower than the current low bound on estimates).

Delta Air Lines

Screen Shot 2018-06-30 at 7.22.41 PM.png

Source: Delta Air Lines Presentation for Deutsche Bank Global Industrials and Materials Summit June 6, 2018

Based upon the guidance and actual spot prices, we can calculate the impact of fuel prices on Q2 earnings for Delta Air Lines:

Screen Shot 2018-06-30 at 10.45.18 PM.png

Source: Author's own calculations based upon Delta Air Lines IR releases and EIA spot fuel prices

As you can see from the chart, jet fuel prices (as paid by Delta Air Lines) were likely about $0.12 higher per gallon than initially projected a month ago by the airline in its guidance. This increase in jet fuel prices would result in a decrease in earnings of about $0.18/share from earlier projections. Pricing actions take at least 6-12 months to be fully reflected in earnings. Therefore, Q2 earnings are highly exposed to increased jet fuel costs. Despite decreased earnings estimates, there is a significant risk that the impact of fuel price increases is still not fully reflected in earnings estimates for Q2 2018. Current earnings estimates for Q2 are $1.70-1.90, with a mean of $1.75/share (per Marketwatch as of 7/2/2018). Even though these have decreased recently, I would not be surprised by an earnings miss of at least $.10/share, which would mean earnings of $1.65/share (mean estimate), lower than the current low bound of earnings estimates.

United Airlines

Screen Shot 2018-06-30 at 7.44.45 PM.png

Source: United Airlines IR April 18, 2018, Q1 Report and Guidance

Based upon the guidance and actual spot prices, we can calculate the impact of fuel prices on Q2 earnings for United Airlines:

Screen Shot 2018-06-30 at 10.45.35 PM.png

Source: Author's own calculations based upon United Airlines IR releases and EIA spot fuel prices

As you can see from the chart, jet fuel prices (as paid by United Airlines) were likely about $0.14 higher per gallon than initially projected a few months ago by the airline in its guidance. This increase in jet fuel prices would result in a decrease in earnings of about $0.51/share from earlier projections. Despite decreased earnings estimates in recent weeks, the impact of fuel price increases still does not appear to be fully reflected in earnings estimates for Q2 2018. Current earnings estimates for Q2 are $2.90-3.24, with a mean of $3.05/share (per Marketwatch as of 7/2/2018). Even though these have decreased recently, I would not be surprised by an earnings miss of at least $.25/share, which would mean earnings of $2.80/share (mean estimate), lower than the current low bound of earnings estimates.

Conclusion

In conclusion, the headwinds from jet fuel price increases appear to have outpaced the official guidance from the airlines and the street. Therefore, I would expect an earnings miss from Delta Air Lines, when earnings are reported later in July, at least as compared with current expectations. American and United will thereafter also have their earnings expectations reduced.

Overall, the stock prices of the airlines have been falling for the past several weeks at least partially due to fuel price increases. The street will be looking to see if fuel price increases are beginning to be passed on to consumers in the form of higher ticket prices when earnings are released. If ticket pricing trends are positive in the earnings report, then the street may not react negatively, even if earnings don't meet expectations. Long term, the airlines are still a compelling industry due to their continued high margins and decreased competition due to mergers earlier in the decade. However, at the moment, I would not add to current positions in the airlines until the impact of fuel prices becomes clearer.

Disclosure: I am/we are long AAL, UAL.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.