If that wasn’t enough, fuel prices have caused their share of damage – prices have been declining lately, thus leading to a drop in the revenue of airline players. What remains to be seen is how each player fights with the situation, and on this basis, I can suggest what position to take in these stocks.
How declining fuel prices have led to declining revenue
Common sense suggests that declining fuel prices should be a plus for the airline industry. However, history has shown us that fuel and airline revenue move in a close (though lagged) relationship.
The near-term correlation between fuel and revenue has been a weak one, but with a lag of four months the correlation has been as high as a positive 80% to 90%. Therefore, a decline of $0.30/gallon in jet-fuel costs in the last 15 days or so convinces me to believe that revenue growth is expected to slowdown in the coming months.
The decline in fuel prices has helped the Street to believe that April revenue per available seat mile, or RASM, a measure of calculating revenue, will be lowest in the second quarter of the year. However, one should not forget that a decline in fuel prices also means an improvement in the bottom-line (despite the companies hedging fuel price volatility).
More than an earnings review
Apart from concerns regarding declining fuel prices, a weaker-than-expected March RASM result has also been disturbing airline investors. Therefore, future guidance will be watched closely this earnings season. Airline companies have already started reporting their results.
On April 23, Delta Air Lines, Inc. (NYSE:DAL) reported its results. Early on, the company had implicitly guided for RASM as it previewed its operating margin expectations. For the second quarter of 2013, the company expected a RASM gain of ~1%. However, the company was able to beat the guidance as it reported a RASM gain of 1.4%.
During its earnings call, Delta Air Lines, Inc. (NYSE:DAL) offered a preview on April RASM. It expects a gain in the 1% to 2% range. Since it was the first airline to report, Delta’s revenue/demand comments are expected to be actionable.
Delta Air Lines, Inc. (NYSE:DAL) has been proactively working to cover its costs. The company produced better-than-anticipated savings from its cost initiatives. The market expects Delta to achieve a long- term goal of flat to a 2% increase in cost-per-available-seat mile (CASM), which is a measure of cost.
Following the reduction in fuel prices in 2Q 2012, Delta Air Lines, Inc. (NYSE:DAL) reported a loss from its hedging positions. While Delta Air Lines, Inc. (NYSE:DAL) has generally reduced its oil hedging amid economic uncertainty, given the drop in fuel prices investors expected the company to guide on the potential impact for the stock.
Investors also expected an update on the refinery benefits as the 2Q is the first quarter with a positive impact from the company’s Trainer, PA facility. The company forecasts fuel prices of $2.95 to $3 per gallon (down from $3.24) in June, due to hedging and refinery benefits.
Allegiant Travel Company (NASDAQ:ALGT) also reported its earnings on April 24. Allegiant was expected to provide April and 2Q 2013 RASM guidance but it didn’t. The carrier was expected to preview an April RASM loss of -7.5 to -6.5% and a 2Q 2013 PRASM gain of 8.5% to 9.5% on a year-over-year basis.
While carriers with leisure exposure reported strong March RASM gains, an early Easter had more of an impact, and I suspect a weaker April was a result.
The carrier recently called off its off-peak Hawaii flying, which has been bullishly received by investors. For no reason, the company has been seen as one of the two favorite low-cost ideas in the airline industry (the other being Spirit Airlines).
Before the release, investors were interested in knowing how the company planned to deploy its 757 fleet, which is currently operating on the Hawaii route. The company believes that demand for the Hawaii route flight is high in the summer months and hence has shifted the Hawaii capacity to domestic mainland routes where its 757 will be more profitable as compared to the MD-80.
Talking about players with high exposure to leisure, JetBlue Airways Corporation (NASDAQ:JBLU) is another name that comes to mind. JetBlue Airways Corporation (NASDAQ:JBLU)’s March RASM result was strong.
However, given broader concerns about revenue following a March RASM (I am talking about the general industry) outcome that was softer than expected, JetBlue Airways Corporation (NASDAQ:JBLU)’s RASM guidance was of interest to investors (before the earnings release). The company previewed a gain of 1.5% to 2.5% range in its April RASM. The RASM is expected to be softer than March in large part due to an early Easter impact.
Following its investor day, JetBlue Airways Corporation (NASDAQ:JBLU)’s tone was focused on the carrier’s revenue and growth opportunities. Barclays PLC (ADR) (NYSE: BCS) is neutral on the stock given that the company is expected to benefit from strong revenue generation and advantageous competitive capacity. Free cash flow is also improving. However, cost performance is calling potential for profitable growth and relative margin improvements into question.
Conclusion
Both Delta Air Lines, Inc. (NYSE:DAL) and Allegiant Travels are recommended as buys despite sluggish expected revenue growth in the near-term because both companies have been actively trimming their costs and hence improving their bottom-lines. However, JetBlue, despite an improving revenue base, hasn’t been able to keep its costs in control and hence is recommended as a hold.
The article 2 Airline Stocks to Buy, 1 to Hold originally appeared on Fool.com and is written by Masam Abbas.
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