Earnings Beat Galore At Airlines: Is All Well Otherwise?

As the first-quarter earnings season draws to a close, we take note of the impressive bottom-line performances posted by many of the airline stocks. On taking a closer look at the releases, it is clear that cheap oil has notably benefitted the airlines’ bottom lines.

It is a well-documented fact that cheap oil has helped airline stocks cut operating expenses to a great extent. The substantial savings has thus helped the carriers boost their shareholder-friendly (dividends, buybacks) and employee friendly (profit sharing) activities.

Is Cheap Oil to Be Thanked?

The first quarter of 2016 has seen major airline companies like Delta Air Lines, Inc. (NYSE:DAL) , Southwest Airlines Co. (NYSE:LUV) , American Airlines Group Inc. (NASDAQ:AAL) , United Continental Holdings, Inc. (NYSE:UAL) and Alaska Air Group (NYSE:ALK) report better-than-expected earnings. Meanwhile, we can take a look at the factors that might have brought about the earnings beats in this quarter.

Oil prices have been weak for over 18 months. Given the extended period of the slump, it is quite natural analysts had already taken this major tailwind for airlines into consideration while arriving at their earnings per share estimates. With cheap oil already factored in, we believe that the reason behind the earnings beats lies elsewhere.

Despite the obvious benefit from the plummeting oil prices, the airline industry is not free from headwinds ranging from passenger revenue per available seat mile (PRASM) woes, strengthening of the U.S. dollar and terror attacks. In view of these headwinds, the earnings per share estimates have been trimmed over the past few months. With the bar (pertaining to earnings estimates) being lowered significantly, courtesy the drastic downward revisions, it is of little surprise that most carriers have managed to beat the (highly conservative) Zacks Consensus Estimate in the first quarter.

It is also to be noted that oil prices have recovered to a great extent over the past few months. Currently, oil is hovering around the $45 a barrel mark, reflecting a significant increase from the 12-year low of $26.21 recorded in February. Thus, it is clear that low oil prices have not been the factor behind the outperformance by the airlines this quarter.

In spite of the impressive earnings performances in the first quarter, there are a number of headwinds prevalent in the airline space. Let’s take a look.

Roadblocks

The main headwind threatening stocks in the space is with respect to a key revenue metric PRASM (a measure of sales relative to capacity for a carrier). As in the past few quarters, this key metric impacted the top line of the carriers in the first quarter too. For instance, sector heavyweights such as Delta, United Continental and JetBlue Airways Corp. (NASDAQ:JBLU) reported lower-than-expected revenues in the quarter hurt by unit revenue woes. Lower fuel surcharges on international flights due to weak oil prices have been one of the main reasons behind the persistent decline in PRASM. Consequently, plunging oil prices have become a double-edged sword for carriers.

That PRASM will continue to hurt the stocks going forward too can be made out from the second-quarter projections for the metric. For example, United Continental expects consolidated PRASM to decline in the band of 6.5% to 8.5% for the second quarter while American Airlines forecasts a 6% to 8% drop in the metric. Capacity-related issues have also been an adverse factor.

Moreover, airline stocks have been hurt by the frequent terror attacks which have affected demand to a great extent. The Brussels attacks (in Mar 2016) impacted Delta’s top line in the first quarter while the Paris assault had impacted Air France-KLM SA‘s (OTC:AFLYY) revenues last year. Furthermore, outbreaks of diseases like the Zika virus and disputes similar to the ongoing one between legacy U.S. carriers and their Gulf counterparts pose challenges to the stocks in the airline space.

To Wrap Up

The above write-up clearly suggests that despite the series of earnings beats in the first quarter, the airline space is not free from challenges. We note that despite posting an earnings beat in the first quarter on Apr 26, shares of JetBlue Airways were hurt by the 8% decline in PRASM to 11.35 cents and 7% fall in operating revenue per available seat mile to 12.41 cents. Moreover, the fact that the NYSE ARCA Airline index has declined above 6% over the past month further substantiates the fact that the series of earnings beats in the airline space have failed to cheer investors.