Airlines will be one of the more interesting industries to watch this earnings season.
It has been a wild couple of years for the group. The global pandemic completely disrupted travel patterns. The industry was grounded and needed a lifeline from governments to keep its business model alive.
Airlines operate on high upfront costs to purchase the aircraft. This leads to high debt levels that need to be maintained through recurring revenue. The lock down led to that revenue stream dissipating.
The group prepares to deliver its Q1 results as it emerges from the fog. Investors see the airlines as relatively cheap, but with good reason as headwinds persist. Airlines may have the widest range of earnings expectations given the volatile environment which means opportunity for investors.
Vaccines eased some of the tension around the pandemic but, as we can see with the lockdowns in China, there remains concern. A return to normal life, particularly in travel, is not a foregone conclusion.
Russia’s invasion of Ukraine has added to the difficult environment. Geopolitical tensions constrain global travel however it is the impact on oil that investors will be watching.
Fuel costs account for a substantial portion of input costs at approximately 25% on average. Deutsche Bank suggested that fuel could be 30% of costs in Q1.
Airlines can protect themselves. They buy futures contracts to lock in costs for a set period. The idea is to make this a fixed rather than variable expense. This should limit the impact in the first quarter. Airline’s ability to manage these rising costs will be a key read on profitability in coming quarters.
The March CPI was released this morning and reflected an 11% increase in airline fares. This was the biggest increase in non-fuel related categories. This suggests some pricing power and the ability to offset some of the rising fuel costs. It should bolster top line growth, but investors want to see the bottom lines for airlines and how these fuel costs impact the ability to service debt.
American Airlines (AAL) provided markets with a positive outlook this morning. It raised its Q1 revenue outlook to a decline of 16% from the first quarter of 2019 (pre-pandemic). The prior outlook was a decline of 17%. It sees Available seat miles (ASM)- a measure of an airplane’s carrying capacity available to generate revenue- at -10.7% which is at the high end of its -10% to -12% guidance range.
These are both positive items which suggest a return of air travel. However, AAL also raised the average fuel price to a range of $2.80-2.85 compared to $2.73-2.78. The impact on earnings and margins is a little less clear. Investors need more information.
Delta Airlines (DAL) will be the first major airline to post earnings. It will post its Q1 numbers Wednesday before the market opens. Current expectations are for the company to report a loss of -$1.27 per share while posting revenue of $8.9 billion. A loss would break a string of two profitable quarters in a row. The revenue growth would be 54% from the prior year.
In a conference call in mid-March, DAL stated that it anticipated a loss due to the impacts of the Omicron variant in January and February. It did note that March would be profitable. This is important as we started to see oil prices skyrocket in early March with a break above the $100 level. The company expects to be profitable in 2022.
DAL expects Q1 revenue to be at 78% of 2019 levels which was above the initial outlook of 72-76%. It projected its ASMs to be flat from the prior quarter as it maintains capacity.
Keep an eye on the revenue per seat mile metric as Delta highlighted that this needs this to be positive to cover the fuel price increases.
Commentary around demand will be of great importance. In a recent note, Citigroup was convinced that domestic travel was returning. The investment bank said there is evidence that higher ticket prices were not having an impact on demand. If this persists and oil cools and crack spreads ease then that would be a big tailwind for the sector. Any evidence that demand eased because of price shock would raise a red flag for the group and consumer stocks in general.
Delta has significant exposure to corporate and international travel. This has lagged the return of domestic travel. Any comments about improved travel in corporate and international would be well received and provide a boost to AAL and United Airlines (UAL).
Shares of DAL staged a big rally heading into the report. The stock slipped to $29.75 on March 7 but has rallied 30% since hitting those lows. Shares are treading water in the $36-39 area ahead of tomorrow’s print. The commentary around demand and its ability to manage fuel costs will go a long way in determining which side of this trading range the stock will break.
Its peers are likely to follow.