Fuel Prices to Foil Airline Profits

The airline industry is currently struggling with higher fuel prices and a slow moving U.S. economy. Fuel prices, though high currently, remain well below the 2008 level of over $140 per barrel that had ravaged the airlines industry.

The largest U.S. low-cost carrier, Southwest Airlines ( LUV - Analyst Report ) , expects fuel costs of about $3.50 per gallon for the ongoing first quarter. This is higher than its previous expectation of $3.35 per gallon. In addition, the company saw weaker-than-expected passenger revenue per available seat miles growth of 4% in February compared with 7% in January. This represents the smallest increase since last July.

The company launches fare sales from time-to-time, with discounted ticket prices in order to boost sales. These actions, however, hurt overall revenues.

As a result, Southwest is not expected to report profits in the current quarter. The Zacks Consensus nevertheless estimates a profit for the first quarter, which remains stable at 3 cents since the year-ago quarter.

The second largest U.S. airline, Delta Air Lines ( DAL - Analyst Report ) , expects fuel costs to grow $250 million in the ongoing quarter. Operating margin is expected in the range of 1–3%, down from the previous expectation of 2–4%.

Although fuel cost will limit the carrier’s profitability, Delta expects revenue growth to outpace the fuel cost. Delta also expects unit revenue growth of 11–15% for the month of March.

The Zacks Consensus estimates loss of 2 cents for the first quarter, representing a massive growth of 95% from the year-ago quarter.

United Continental Holdings Inc. ( UAL - Analyst Report ) , the largest U.S. airline, estimates fuel prices have risen 4% so far this year. Hence, the company plans to cut 0.5–1.5% of its flights this year. Previously, it expected to keep capacity relatively flat and slightly down in the first quarter on a year-over-year basis.

The Zacks Consensus Estimate for the first quarter is a loss of 46 cents, representing a substantial decline of 11.65% year over year.

Overall, air carriers are taking profitable actions to endure surging fuel prices and the ongoing market turmoil. They are successfully passing on the increased cost to customers in the form of fare hikes and effectively using fuel-hedging strategies to combat the rising fuel prices. Delta Air Lines is offering voluntary staff reductions to lower its overall cost and boost its revenue.

Further, major carriers are cutting capacities, rightsizing their fleets, and adding new features to their services as well as introducing new products, which are enhancing their value and profitability.

We prefer to maintain our long-term Neutral recommendation on major carriers like Delta, United Continental and Southwest. For the short term (1–3 months), the stocks retain the Zacks #3 Rank (Hold).