Delta Cuts Q2 Guidance: Can American and United Hold the Line?

FAN Editor

Two months ago, Delta Air Lines (NYSE: DAL) projected that its second quarter pre-tax margin would decline to between 14% and 16% — down from 17.2% a year earlier — largely due to a surge in fuel prices that began last summer. Nevertheless, management still expected double-digit earnings-per-share growth, thanks to the corporate tax cut windfall.

At its investor conference on Wednesday, Delta warned that its Q2 pre-tax margin slump would be steeper than that — and again, it’s pointing to rising jet fuel prices as the culprit. This suggests that American Airlines (NASDAQ: AAL) and United Continental (NYSE: UAL) could also be at risk of missing their earnings forecasts this quarter.

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The oil price spike creates headwinds

In Q2 2017, Delta paid an average of just $1.66 per gallon for jet fuel. By last quarter, that had risen to $2.01 per gallon, and initially, the airline expected to pay between $2.07 and $2.12 per gallon in the current quarter. Based on that guidance, the increase in fuel costs would have represented a greater than 4 percentage point pre-tax margin headwind this quarter.

However, crude oil and jet fuel prices continued to surge higher between early April and late May, although prices have moderated in the past couple of weeks. As a result, Delta now expects its average fuel price for the quarter to land in the $2.20 to $2.25 per gallon range.

Delta Air Lines’ non-fuel unit cost growth is also trending toward the high end of the company’s guidance range for the quarter at 3%. On the flip side, revenue per available seat mile (RASM) trends remain strong. Delta now expects RASM growth in the upper half of its original 3% to 5% guidance range this quarter.

The tweaks to Delta’s unit revenue and non-fuel unit cost forecasts roughly offset one another. However, the increase in its fuel cost estimate represents an incremental margin headwind of more than 1 percentage point. As a result, Delta has reduced its adjusted pre-tax margin guidance from a 14% to 16% range to a 13% to 14% range. It now expects to report adjusted earnings per share in the $1.65 to $1.75 range this quarter — well below its original guidance range of $1.80 to $2.00, but still up slightly from last year’s Q2 adjusted EPS of $1.64.

Not much to worry about here for Delta

Following this guidance update, Delta Air Lines shares slipped about 2% on Wednesday, as of 12 p.m. ET. That said, there was nothing shocking about the cut in its earnings forecast. Delta’s management has consistently said that it takes up to a year to recoup fuel price increases in the form of higher fares. Moreover, the carrier still expects to post a double-digit pre-tax margin this quarter.

Delta’s solid mid-single-digit unit revenue growth shows that it has pricing power, and is already using it to offset its rising fuel costs. Furthermore, its investor presentation hinted at potential plans to cut capacity to boost unit revenue. Management will evaluate revenue and fuel cost trends over the next month and then implement changes to the fall schedule if necessary.

The only item of real concern was the increase in the carrier’s non-fuel unit cost forecast. Yet Delta is sticking with its full-year guidance for its non-fuel unit costs to land better flat and up 2%. That means it expects non-fuel unit costs to be flat or down year over year in the second half of 2018.

The stakes are higher at American and United

In recent years, most major airlines stopped hedging their fuel costs. As a result, American Airlines and United Airlines are likely facing the same pressures on their Q2 results as Delta, relative to the forecasts they gave in April.

However, there’s one key difference: American and United are far less profitable than Delta Air Lines. Indeed, American Airlines’ initial Q2 guidance called for a 7.5% to 9.5% pre-tax margin. United’s pre-tax margin guidance range wasn’t much better, at 9% to 11%. Both carriers also have weaker balance sheets than Delta, so they have less room for error.

So far, American and United have sent mixed signals about their ability to make up for rising fuel costs. American Airlines CEO Doug Parker recently said that airfares would go up in response to rising fuel prices, but not in the near term. This suggests that American Airlines isn’t about to soar past its Q2 unit revenue forecast.

Meanwhile, United Airlines President Scott Kirby affirmed the company’s full-year EPS forecast during an investor presentation in late May. Yet this forecast assumes a solid improvement in the company’s earnings trajectory in the back half of the year. That will be hard to achieve if oil prices remain at recent levels, particularly since United has shown no interest in slowing its growth.

Delta Air Lines stock declined more than its peers after the guidance update on Wednesday. That said, American Airlines and United Airlines are far more vulnerable if oil prices remain high for an extended period of time.

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Adam Levine-Weinberg owns shares of Delta Air Lines. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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