Airline Investors Have Been Waiting for a Dose of Good News: They Just Got 3!

After a month filled with troubling signs, airline investors just got deluged with good news.

Jul 10, 2014 at 2:05PM

Shares of U.S. airlines have been slammed by a litany of bad news in the past month or so, driving sharp corrections in many airline stocks. Fortunately, the airlines got a breather on Wednesday.

American Airlines (NASDAQ:AAL) and Southwest Airlines (NYSE:LUV) both provided very strong outlooks for Q1 unit revenue and earnings. United Continental (NYSE:UAL) -- which has been struggling for the past few years -- also expects to beat its earlier expectations for Q2 unit revenue and unit costs.

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American Airlines reported solid unit revenue trends for Q2. Photo: American Airlines

The sudden return of good news reinforces the fact that air travel demand is still strong, while capacity (especially domestic capacity) remains in short supply. That said, airline bulls shouldn't throw caution to the winds. Comparisons will get much tougher this fall, at the same time that air travel demand typically enters a seasonal low period.

A solid update from American Airlines
American Airlines started off the airlines' party on Wednesday morning. The carrier reported that passenger revenue per available seat mile, or PRASM, increased by 5.5%-6.5% during Q2. That falls right in the middle of the company's previously provided range of 5%-7%.

American Airlines added that it expects a Q2 pre-tax margin of 12%-13%, excluding special items. That will put it near the top of the airline industry. Historically, double-digit profit margins have been rare for airlines. However, industry consolidation is allowing most airlines to report dramatically higher earnings than in prior years.

A strong follow-up from Southwest
Southwest Airlines reported strong June results of its own shortly after American Airlines. Southwest saw its load factor for the month increase from 85% to 86.1%. This strong demand helped drive a 7%-8% unit revenue increase. For Q2, Southwest now expects PRASM to increase by more than 8%.

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Southwest Airlines said that unit revenue rose more than 8% in Q2. Photo: The Motley Fool

On the flip side, Southwest Airlines projected back in April that non-fuel unit costs would increase just 2%-3% in Q2. (Fuel costs are likely to be approximately flat.)

Southwest will take a revenue hit from lower fees as it has been switching more flights from the AirTran brand (which charges for checked bags) to the Southwest brand (which does not charge for checked bags). Nevertheless, the combination of strong PRASM growth and modest unit cost growth should drive several points of margin improvement for Q2.

United Continental performs better than feared
Even United Continental -- which has been an industry laggard for the past couple of years -- had some good news to share on Wednesday. The company announced that Q2 PRASM increased about 3.5%.

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United reported that unit revenue rose more than expected in Q2 (Photo: The Motley Fool)

That represents the lowest unit revenue growth among the big 4 U.S. airlines. However, it's still better than what United had previously expected -- in April, it projected PRASM growth of just 1%-3%. United also reported better than expected unit cost trends for Q2, due to a variety of cost-saving initiatives, as well as the timing of some expenses.

A few things to keep in mind
Based on the slew of upbeat airline reports from Wednesday, investors can expect most airlines to report strong earnings growth later this month. This suggests that positive industry trends are continuing, and it bodes well for the busy summer travel season.

However, investors should also remember that airlines' Q2 results benefited from the shift of Easter travel from March to April. This probably boosted unit revenue for the quarter by around 1 percentage point for most airlines. Airlines also faced easy comparisons in April due to the disruption caused by FAA furloughs in April of 2013.

Lastly, the airline industry upturn, which began in earnest last year, is encouraging airlines to ramp up their growth plans. Industry capacity growth looks set to gain steam next year and into 2016. Southwest Airlines and several other low-cost carriers plan to grow more aggressively to exploit some of the big opportunities available.

Foolish final thoughts
After tumbling last week, airline stocks have reversed and are flying higher. Solid unit revenue reports from American Airlines, Southwest Airlines, and United Continental are rebuilding investors' confidence in the airlines.

That said, all of the data released this week were backward-looking. While the summer travel season is sure to be strong, the outlook for airlines beyond Labor Day is less clear. Airlines cannot continue to expand margins as they have during the past two years -- eventually, this margin growth will attract new competition. If airline stocks rally much further, investors should consider taking some money off the table.

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Adam Levine-Weinberg is short shares of United Continental Holdings. The Motley Fool has no position in any of the stocks mentioned. 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.

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