Epic Fail -- a Glance Into Airline Earnings

Only in the airline sector can you find failure being rewarded on a near-quarterly basis. Much like the trading we witnessed in 2008, investors are turning a blind eye to the actual quarterly results and rewarding the airline sector for reporting results that "aren't as bad as expected."

Fueling a recession
Rising fuel costs and tighter consumer spending are wreaking havoc on the bottom lines of the nation's largest airlines. Having reported over the past week, Alaska Air (NYSE: ALK  ) , US Airways Group (NYSE: LCC  ) , United Continental Holdings (NYSE: UAL  ) , and AMR (NYSE: AMR  ) all alluded to drastically higher fuel costs eating into their profits. Below is a summary of the fuel cost jump that each airline experienced.

Company

Fuel Cost Jump Over Year-Ago Period

Alaska Airlines 55%
US Airways 47%
United Continental 45%
AMR 33%

The question, therefore, is whether we should look past the sector's "Mickey Mouse economics" where each company takes into consideration what it would have earned prior to fuel costs and hedging, or if we should treat the earnings as a black-and-white exhibit of the health of the sector. Consider me part of the latter camp.

The good, the bad, and the ugly
Of the four airlines to have already reported, Alaska once again seems to be the bullish standout. While its fuel costs rose more quickly than any of its peers, Alaska was able to pass along price hikes to consumers and dramatically increase its overall traffic by 10.3%. Passenger revenue per available seat mile rose an impressive 6.8%, which backs up the notion that its customers are willing to accept recent price hikes.

Wall Street seems fairly content with United Continental and US Airways quarterly figures -- but call me skeptical. For US Airways, traffic and passenger revenue per available seat rose much like Alaska, but unlike Alaska, US Airways doesn't have the same batch of loyal customers willing to accept price increases. US Airways may find itself struggling to raise its prices fast enough to match soaring fuel costs.

United Continental actually reported what I would deem a stinker of a quarter. Not only are rising fuel costs a concern, but slower than anticipated combined labor union deals between the two former companies and flat traffic results relating to fewer flights to Japan are complicating matters. The only saving grace for United Continental this quarter was a $278 million hedging gain. One-time gains can only carry this company so far, so keep that in mind.

The true stinker of the bunch, even worse than United Continental, was AMR. AMR looks poised to be the only major carrier to report a loss this quarter despite its fuel costs going up considerably less than the majority of the sector. Following this week's mammoth 460-plane order from Boeing (NYSE: BA  ) and Airbus, I feel investors have to be concerned about AMR's weakening margins and inability to get its customers to accept higher fares.

You'd be quackers to buy here
If it walks like a duck, and talks like a duck ... chances are it's a duck! The airlines can sugarcoat their earnings reports all they like, but it's clear that only a select few customer bases are willing to accept rising airfares. If fuel costs keep surging, and nothing right now suggests they won't, no amount of "woulda, coulda, shoulda" is going to keep these stocks from being grounded.

Should airline stocks be flying high or grounded based on these initial earnings reports? Share your thoughts in the comments section below and consider adding Alaska Air, US Airways, United Continental Holdings, and AMR to your watchlist to keep up on the latest in the airline sector.

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that always knows where the exits are located.


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On July 22, 2011, at 3:23 PM, ArmChairCritic wrote:

    Hardly epic. I'm no admirer of airline mgmt, but the unpopular ancillary fees have stuck, and now make all the difference.

    Airlines are now once again an oil play. If oil drops, all these airlines' numbers (even AMR's) improve.

    Oil rises and these numbers worsen. But it's notable that they're all (minus AMR) still profitable at $100 oil...which was unthinkable 2-3 years ago.

  • Report this Comment On July 22, 2011, at 4:25 PM, TMFGemHunter wrote:

    I don't see how UAL's fuel hedging constitutes a "one-time gain". They have an on-going fuel hedging program, as do most other carriers (aside from LCC). These will continue to limit the downside risk of skyrocketing oil prices and contribute to profits on an on-going basis.

    I happen to think that oil prices are going to peak in the next few weeks and then fall, possibly south of $90. The past few weeks' supply data has sent oil prices up due to falling stocks of crude. However, this has been more than offset by increasing stocks of petroleum products. Ultimately, refiners are going to slow down if they can't sell their products, and crude prices will recede...

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