Sunday, October 19, 2014

U.S. Airlines to Deliver Strong Profits: Carriers’ Share Prices, However, Fail to Take Off Amid Concerns About Ebola, Economic Slowdown

The Wall Street Journal
Oct. 19, 2014 1:55 p.m. ET

A flock of U.S. airlines is expected to report strong quarterly profits this week, following the lead of Delta Air Lines Inc. But one would be hard-pressed to find evidence of that in share prices that have been battered by concerns over everything from a global economic slowdown to Ebola.

Airline stocks, most of which soared earlier this year, have lost much of that altitude in the past three months, although they are off their recent swoons. Still, American Airlines Group Inc. shares have fallen 20% since mid-July, while Delta shares are down nearly 6% and Alaska Air Group Inc. stock is down 7%. United Continental Holdings Inc. stock showed a tepid 3% gain and Southwest Airlines Co. a more robust jump of 13%.

The broader market also has been in turmoil, with the Dow Jones Industrial Average falling for several days in a row last week before rallying on Friday. For airlines, the past few weeks have been particularly volatile. Investors already had been fretting about growing international airline capacity and dwindling unit revenue gains. Then a second Ebola case involving a health-care worker from Dallas was discovered—after the woman took two domestic flights, heightening travel concerns among some would-be fliers.

Investor sentiment “is hugely negative,” said Helane Becker of Cowen & Co. “We are seeing investors sell into strength, despite significantly lower jet fuel and improving margins.”

The first half of 2014 was a halcyon period after years of industry consolidation. It was marked by record airline financial results, soaring stock prices, ratings upgrades and the launch of new programs to reward investors with dividends and share buybacks. The rest of the year was looking promising as well. Several recent investor updates from the airlines about their September results continued to point to strong earnings, although unit revenue gains have tailed off against difficult prior-year comparisons.

Helping matters, jet-fuel prices have plummeted 15% since the beginning of September. Because fuel accounts for a third of airlines’ costs, CRT Capital Group LLC’s Michael Derchin said he expects lower prices to trigger higher fourth-quarter and 2015 earnings estimates. If fourth-quarter fuel prices are 10 cents a gallon lower than currently estimated, airlines’ average earnings per share would climb by 11%, he said. For all of 2015, on the same basis, earnings per share would rise 10%.

Delta last Thursday delivered on its earlier guidance. It reported profit of $1 billion, excluding numerous one-time items, achieved a 15.8% operating margin, booked higher revenue than expected and guided to a record fourth-quarter. The company also said its bookings aren’t being affected by Ebola fears.

But the market still has the jitters. “We are unable to reconcile [the] recent equity pummeling with current fundamentals, or with recent airline credit performance,” said J.P. Morgan ’s Jamie Baker. “We remain optimistic that the unusual combination of Ebola fears, Mideast unrest and softening global indicators have conspired to create inordinate pessimism.” And that, he noted, could represent a buying opportunity.

One investor pain point over the summer was a fairly aggressive planned capacity buildup on international routes, where unit revenues have been negative through August of this year due to slowing European demand and continued weakness in Asia and Latin America. Many of the added seats and flights were scheduled by foreign carriers, but U.S. airlines added to the problem. However, now they are culling some of that planned international capacity in the coming months, reassuring shareholders.

Meanwhile, domestic demand appears to remain strong, with a track record of positive unit-revenue gains. But there are new concerns that domestic capacity is creeping higher, which could erode pricing power. Glenn Engel of Bank of America Merrill Lynch estimates that domestic capacity will grow 3% in 2015, up from just 1% growth in 2013. Most of that capacity is being added by point-to-point budget airlines, not the big network players, he said.

The wild card is Ebola and whether cases will spread in the U.S. “We believe the selloff implies an assumption of a worst-case rather than a likely-case Ebola scenario,” said Hunter Keay of Wolfe Research. “Ebola is not an airborne virus…and the outbreak remains largely contained to Third World, not emerging economies. Just 0.03% of airline seats from U.S. airlines even go to countries significantly impacted by Ebola.”

Jim Corridore, an analyst for S&P Capital IQ, said he remains soundly positive about the sector. “I’m not saying Ebola isn’t a serious issue,” he said. “But we’ve had no cases of pilots getting sick, no cases on planes. I think we’re overreacting. We might see the best fourth quarter in the U.S. airline industry.”

American, United, Southwest, Alaska and JetBlue Airways Corp. are slated to report results on Thursday. American, the top U.S. carrier since its December merger with US Airways, is expecting to generate a pretax margin of 10% to 12%. United, No. 3, is expected to nearly double its earnings per share. Southwest, No. 4 and the largest discounter, is expected to boost its per-share earnings to 53 cents from 34 cents a year ago. All are looking to produce higher revenue.

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