Major U.S. airlines kicked off earnings season with mixed results last week, highlighting the headwinds facing an industry that generates $175 billion in annual revenue, but keeps just 2 cents of every dollar as profit.
With margins that tight, saving pennies a gallon on fuel or trimming capacity to cut costs is often the difference between profit and loss in this capital-intensive, highly regulated industry.
Those were among the themes as four major U.S. carriers — Delta Air Lines (NYSE:DAL), United Continental (NYSE:UAL), US Airways (NYSE:LCC) and Southwest Airlines (NYSE:LUV) — reported earnings last week. Not surprisingly, some carriers posted a better report card than others. Here’s a quick recap:
The good news: For the full year, Delta Air Lines (NYSE:DAL) grew net income 18% to $1 billion ($1.19 a share) on nearly $36.7 billion in revenue. The company successfully trimmed its seating capacity to gain pricing power. The bad news: DAL’s fourth-quarter earnings slipped to a scant $7 million — a penny a share on revenue of $8.6 billion — down from the $425 million (51 cents a share) it reported a year earlier.
Pricier fuel — and higher-than-expected non-fuel costs — contributed to the loss. Superstorm Sandy dealt a $100 million blow to DAL’s fourth-quarter profit. In addition to canceling thousands of East Coast flights, the late October storm slowed production at Delta’s Pennsylvania oil refinery. The refinery, which the airline bought last year to cut fuel costs, lost $63 million in the fourth quarter.
Add to that an 8% increase in operating expenses and a $122 million charge for fleet restructuring. DAL is leasing 88 Boeing (NYSE:BA) 717 jets from Southwest and has ordered 40 new CRJ9000 regional jets from Bombardier Aerospace to replace inefficient 50-seat jets at its Delta Connection subsidiary.
DAL shares have gained more than 60% since September, but still look great on a valuation basis, trading at 5 times 2014 earnings and a price/earnings-to-growth ratio of 0.21.
Delta’s purchase of a 49% share of Virgin Atlantic is a big positive, giving it better access to slots at London’s profitable Heathrow. But costs remain a big concern — DAL has set a target of $1 billion in structural cost cuts. Although Delta’s Trainer refinery is scheduled to begin processing cheaper Bakken crude into jet fuel in the first quarter, I’m still not sold on the near-term benefits. DAL’s increase in operating expenses is a concern that bears watching.
United Continental: D+
United Continental‘s (NYSE:UAL) disappointing Q4 results — a $620 million loss ($1.87 a share) compared to a $138 million (42 cents a share) loss a year earlier — illustrate that the devil is in the details of airline mega-mergers.
UAL was hammered by major systems glitches last year as the airline attempted to convert to a single passenger information system. Glitches cancelled and delayed flights, stranded travelers and drove off some of UAL’s best customers as its passenger traffic fell by more than 3% in the last three months of 2012. For the full year, UAL lost $723 million on $31.2 billion in revenue.
During the earnings call, United CEO Jeff Smisek characterized 2012 as the toughest year of its merger integration, although he expressed confidence that the airline is now “back on track.” UAL announced plans to cut 600 front-office jobs in an effort to streamline operations.
UAL’s forward P/E of 5 and its 0.45 PEG are on par with its rivals, again amid its own run of nearly 50% since August. Its operational metrics also have improved in recent weeks, but United Continental still has a lot of work to do to win back profitable corporate travelers.
The grounding of Boeing’s 787 Dreamliner over lithium ion battery problems doesn’t help United, the only U.S. operator of the aircraft. Smisek remains confident that Boeing will fix problems with the aircraft.
Bottom line: UAL still faces real and perceived challenges in 2013 that could impact earnings in the first half of the year.
US Airways: B
US Airways‘ (NYSE:LCC) blockbuster Q4 and full-year earnings went a long way toward reassuring investors that its bid for bankrupt American Airlines’ parent AMR Corp. (PINK:AAMRQ) is no desperation move.
Earnings more than doubled to $37 million (22 cents a share) on a record $3.3 billion in revenue in the fourth quarter. For the full year, LCC posted the highest annual profit in its history — $637 million ($3.28 a share), compared to $71 million (44 cents a share) a year earlier.
Just like the others, LCC has run hot, up 30% in the past six months. It also has a dirt-cheap PEG of just 0.07. The company ended 2012 with nearly $2.7 billion in cash and has grown annual profit from $111 million in 2011 to $537 million last year.
Even without a deal for American, LCC is doing an impressive job of managing costs and boosting revenue per available seat mile (RASM), a key measurement of profitability. Like the rest of the industry, however, US Airways faces headwinds over fuel costs.
Although LCC has placed modest orders for new aircraft, an AMR merger brings with it more than 500 new, fuel-efficient aircraft over the next decade. I think the odds for a deal have improved in recent weeks, though much of that altitude has been priced in.
There’s still a lot to love about Southwest (NYSE:LUV), even though the carrier reported a huge drop in Q4 earnings, to $78 million (11 cents per share) from $152 million (20 cents) a year earlier. LUV faced challenges with higher expenses: Maintenance costs soared 13% as the carrier refurbished aircraft, while labor costs increased by 4.5%.
Full-year earnings looked better, though: LUV earned $421 million in 2012 on more than $17 billion in revenue.
Southwest’s integration with AirTran has been less turbulent than UAL’s so far, but we’re still relatively early in the process and the carriers are smaller. Still, once the carriers have been completely integrated — which is expected by the end of 2013 — LUV anticipates to gain $400 million in synergies.
LUV has gained roughly 30% in the past three months (notice a pattern?), though that run is showing in its forward P/E, which at nearly 10 is double that of its legacy competitors.
Southwest continues to do a lot of things right from an operational perspective, too. Leasing AirTran’s Boeing 717s to Delta was done to preserve the substantial cost and maintenance advantages of operating a single aircraft type: the Boeing 737. It has continued to realize moderate capacity growth, but not at the expense of passenger revenue yield.
That said, I’d be surprised if Southwest did not experience some merger-related systems challenges in 2013.
As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.