Passenger Revenues May Aid Airlines' Q3 Earnings: Here's Why

Delta Air Lines (NYSE:DAL) will kick start the third-quarter 2019 earnings season for stocks in the airline space on Oct 10. Headwinds like high non-fuel unit costs, declining cargo revenues and flight cancelations by various carriers in the wake of Hurricane Dorian are likely to dull the third-quarter earnings picture of airlines.

The carriers with Boeing (NYSE:BA) 737 MAX jets in their fleet should see an upsurge in non-fuel costs due to the grounding of the jets. For example, Southwest Airlines (NYSE:LUV) , which has 34 Boeing 737 MAX jets in its fleet, expects non-fuel unit costs to increase between 8% and 10% when it releases third-quarter results on Oct 24.

Hurricane Dorian is also likely to play spoilsport. Spirit Airlines (NYSE:SAVE) , which canceled 768 flights due to Hurricane Dorian, now expects third-quarter adjusted non-fuel unit costs to increase in the 9-10% range, reflecting a 200-basis point increase from the prior estimate. The bearish view is due to reduced capacity and higher costs associated with Hurricane Dorian.

Both the aforementioned airline companies carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Price Performance

Mainly due to the above-mentioned headwinds the Zacks Airline industry declined 2% in the past three months, underperforming the Zacks S&P 500 composite’s 0.2% gain in the period.

Passenger Revenues to the Rescue

However, despite the adversities, strong demand for air travel is likely to result in a solid uptick in passenger revenues for airlines in the quarter to be reported. Additional traffic during the busy Labor Day holiday period should provide further boost to the top line. This is because passenger revenues account for bulk of total revenues for most carriers. For instance, passenger revenues at American Airlines (NASDAQ:AAL) and Southwest Airlines accounted for 91.7% and 92.5% of the top line, respectively, in first-half 2019.

Mainly due to strong demand for air travel, we expect carriers to perform well on the unit revenue front in the September quarter. For example, Alaska Air Group (NYSE:ALK) expects revenue per available seat mile (RASM: a key measure of unit revenues) to rise in the 3-5% range year over year (the earlier outlook projected an increase in the 2-5% range).

A much-improved job market in the United States and rising disposable income, have provided consumers an added incentive to opt for air travel. Upbeat demand apart, the rise in average air fare in the United States (up 2.3% and 1.7% month on month in July and August, respectively,) is likely to result in further uptick in airlines’ passenger revenues in the to-be-reported quarter.

We believe that airlines are trying to balance out the increase in non-fuel unit costs by pushing up fares in a bid to maintain their profit levels. The strong demand scenario is not only limited to U.S. carriers. Their Latin American counterparts are also benefiting from strong passenger traffic due to solid demand.

With economic improvement in the region, prominent carriers like Azul (NYSE:AZUL) and Gol Linhas Aereas Inteligentes (NYSE:GOL) have reported encouraging traffic statistics in the first two months (July and August) of the third-quarter period.

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