With American Airlines (AAL) stock down by 4% by mid-afternoon trading on Friday, the market wants you to believe that the airline’s second-quarter financial figures came in disappointing.
Well, if revenue is the only metric you use to judge how a company is faring, then you should believe Mr. Market. But you should also know that American Airlines reported a net profit of $1.9 billion, the highest quarterly net profit the history of AAL.
Operating revenues for the second quarter dropped 4.6% to $10.8 billion compared to the $11.4 billion raked in the year-ago quarter. This is attributable to a 6.8% dip in mainline passenger revenue and a 12.3% dip in cargo revenue.
While that doesn’t give a good impression, I believe investors should refrain from reading too much into revenue data. You have to remember that, in the air travel business, there is dearth of sophisticated products (unlike a company like Apple) to entice customers to “buy” more.
The model is simple and similar across the industry; get travelers to their desired locations. This is enough reason for revenue to rise and drop from time to time.
Why AAL Stock is Winning
That said, one aspect of the earnings that brings value out of the revenue data — and to some extent the shows that the company is in a healthy position — is its operating expenses trend.
For the second quarter, operating expenses dropped 10.5% to $8.9 billion from $10 billion in the prior year quarter. In an earlier article, I plotted out how American’s merger with US Airways has helped American Airlines grow its revenues faster than its operating expenses. The latest figures go to confirm that the company is benefiting from healthier competition.
Still have doubts? Take a look at this.
AAL said its selling expenses for the second quarter dropped 13% year-over-year. Just to be clear, selling expenses include items like,
“Sales commissions, advertising, promotional materials distributed…salaries and fringe benefits of sales personnel, utilities and telephone usage in the sales department, etc.”
It’s safe to say most of these costs are the price of staying competitive. So the fact that selling expenses is decreasing further strengthens my belief that the merger with US Airways is making AAL a stronger and healthier company.
AAL Stock Poised To Benefit From Repurchase
AAL also reported that its board has approved a further $2 billion repurchase program to be completed by December 2016. The company has thus approved a total of $4 billion repurchase program so far in 2015. This news suggests that AAL thinks that the current financial position will last.
Airlines, including AAL, have been soaring mainly because of low fuel costs. After all, AAL experienced a year-over-year 36.9% decrease in consolidated fuel cost during the second quarter. So Wall Street is unsure of what will become of airline stocks, including AAL stock, should fuel cost ever return to where it was prior to July 2014.
While that’s enough to worry about, I believe low fuel prices are veiling the new-found stability in the airline industry, particularly for AAL. And that’s the same message AAL is trying to pass across with the new share repurchase program. Once the merger with US Airway is 100% done, AAL is well-positioned to rule the airline industry.
Note that AAL is delivering these record numbers while its operational efficacy is being hampered by moving parts of its merger. AAL says it recognized $231 million in merger-related expenses — in just a single quarter. Imagine how good earnings would have looked without that $231 million charge.
A Few Potential Hiccups to Note
Fuel Factor: With a 37% drop in fuel costs, AAL’s current profitability is largely based off fuel savings. Consequently, an increase in fuel cost could hamper profitability. However, don’t think this will make the company unprofitable. If fuel costs increases, passengers will be responsible for a large portion of it.
Bill to place a cap on luggage fees: The House of Representatives is introducing legislation to place a cap on what airlines can charge for checking luggage. If this eventually becomes reality, then AAL have one fewer avenue through which to grow its revenue.
Overall, however, I believe it’s a good time to be an investor in AAL stock.
As of this writing, Craig Adeyanju did not hold a position in any of the aforementioned securities.
