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.
