Pricing Power Lifts Airline Earnings Outlook

But headwinds remain for an industry plagued by high costs, razor-thin margins

   

In a rare ray of sunshine for the global airline industry, the International Air Transport Association (IATA) has revised its earnings outlook upward for the rest of the year. But watch out — strong headwinds could hamper any short-term lift in the space.

IATA, the trade association that represents about 80% of global air carriers, has upped its 2012 earnings forecast to $4.1 billion from the $3 billion forecast in June. Before investors get too excited about airline profitability, though, it’s worth noting that the new estimate is less than half the $8.4 billion the industry earned in 2011, and revised profit margins only inched up to 0.6% (from the 0.5% forecast in June). Last year, airline profit margins were 1.4%.

So how are airlines making money? North American airlines like United Continental (NYSE:UAL), Delta (NYSE:DAL), U.S. Airways (NYSE:LCC), Southwest (NYSE:LUV), AMR’s (PINK:AAMRQ) American and JetBlue (NASDAQ:JBLU) are cutting capacity and costs while boosting ancillary fees.

IATA forecasts North American carriers will post $1.9 billion in profit this year – besting the $1.3 billion it earned last year and accounting for the largest improvement among all regions. The lion’s share of the credit goes to tight capacity management — substituting smaller planes with fewer seats for big gas-guzzlers. Over the first eight months of this year, passenger demand grew by 1.3%, but capacity expanded by just 0.2%.

That comes as no surprise to frequent flyers, who consistently find themselves on fuller flights these days. Load factors — airlines’ measurement of how much of their passenger capacity actually is being used — have averaged a whopping 83.2% so far this year.

Baggage fees have added a few extra coins to airlines’ coffers this year as well. In the first six months of the year, U.S. airlines raked in a record $1.7 billion in baggage fees, according to the Bureau of Transportation Statistics.

DAL led the pack with $429 million; United and American posted $351 million and $288 million, respectively; while US Airways took fourth place with $260.5 million.

While these improvements are good news for an embattled industry, “better” is still a far cry from “good.” Tony Tyler, IATA’s director general and CEO, was careful to temper any enthusiasm in remarks on Monday:

“The European sovereign debt crisis lingers on; China continues to moderate its growth. And the impact of recent quantitative easing in Japan and the U.S. will take time to yield growth. While some of these risks have diminished slightly over recent months, they continue to take their toll on business confidence. The outlook improvement is due to airlines performing better in a difficult environment.”

Oil price volatility continues to be a major challenge for airlines. IATA noted that prices on the industry’s benchmark Brent crude have jumped from $90 a barrel in June to $115 a barrel in August; the group forecasts an average price of $110 a barrel through the rest of the year. To make matters worse, jet fuel prices have increased to $127.70 a barrel since June, a move that’s adding $1 billion to the industry’s annual fuel bill.

Bottom line, the IATA report is better news for the airline industry, which in recent years has been hard-pressed on every side. But better performance doesn’t necessarily make the sector investible now. Here are some individual winners and losers now.

Winners

Hawaiian Holdings (NASDAQ:HA). HA is perennially at the top of on-time performance and has fewer lost or mishandled bags and fewer customer complaints than competitors. It has a market cap of about $287 million — small, but still more than twice the size of AAMRQ. I think HA has a solid business plan. The stock is trading around $5.50, it has a P/E-to-growth (PEG) ratio of 0.23 and has a forward P/E of less than 4.

JetBlue. JBLU logs high customer satisfaction ratings and ranks near the top of performance metrics like on-time arrival and baggage handling. The airline broke ground on a new terminal expansion at New York’s Kennedy airport this week, which will handle international arrivals. JetBlue seems intent on stealing some of Southwest’s thunder as the historical passenger favorite loses a step as it integrates AirTran. JBLU has a market cap of $1.4 billion and is trading around $5. It has a PEG ratio of 0.26 and a forward P/E of under 8.

Losers

United Continental. Mega-mergers are tough on everybody, and the fine points of combining United and Continental have wreaked havoc on the airline’s systems this year, causing UAL’s performance metrics to plummet and customer complaints to soar. In July, more than one-third of UAL’s flights were delayed. Last week, the airline said its passenger revenue likely dropped 1.4% for the quarter ended Sept. 30. UAL has a market cap of $6.6 billion and is trading around $20. While its PEG ratio of 0.37 and forward P/E of around 4 may look appealing, I’d wait until the airline gets its performance metrics moving forward again.

American. Volatility has been the watchword of AAMRQ since American’s parent AMR filed for bankruptcy last November. Speculation over a tie-up with U.S. Airways — and recent merger talks with British Airways parent IAG — have given the stock altitude, but the airline has faced multiple delays and cancellations in the wake of voiding its pilots’ union contract in court. Now the airline is experiencing loose passenger seats and smoky cabins on planes in flight. AAMRQ is still losing money due to bankruptcy charges; even at just $0.40 a share, wait until the dust settles to buy this stock.

As of this writing, Susan J. Aluise did not hold a position in any of the stocks named here. 


Article printed from InvestorPlace Media, http://investorplace.com/2012/10/pricing-power-lifts-airline-earnings-outlook/.

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