Profitability has been plunging at American Airlines Group (NASDAQ:AAL) since the beginning of 2016. American's pre-tax margin fell to 9.1% last year, down from a peak of 15.3% in 2015. The carrier is bracing for more margin erosion in 2018, as airlines haven't been able to raise fares sufficiently to offset rising fuel costs.
However, American Airlines investors have been hoping that unit revenue growth would gradually accelerate in 2018. Instead, they got more bad news this week, as American cut its second-quarter unit revenue forecast.
Another guidance cut for American Airlines
In early 2018, American Airlines projected that adjusted earnings per share would be between $5.50 and $6.50 this year. It slashed that EPS forecast to a range of $5 to $6 in April, blaming rising jet fuel prices. (The market price of jet fuel increased from $1.90 per gallon at the beginning of the year to around $2.10 per gallon by the end of April.)
American Airlines also published official second-quarter guidance in late April. It projected that revenue per available seat mile would increase 1.5% to 3.5% but that its adjusted pre-tax margin would fall to a range of 7.5% to 9.5%, compared with 13.5% a year earlier.
On Wednesday, American Airlines cut its Q2 unit revenue growth forecast to a new range of 1% to 3%. The carrier also increased its second quarter fuel cost guidance by $0.06 per gallon. On the other hand, American reduced its estimate of non-fuel unit cost growth by 1 percentage point. It attributed this change to airport rent credits and lower-than-expected maintenance costs.
The good news is that better non-fuel unit cost performance allowed American Airlines to hold its pre-tax margin forecast range at 7.5% to 9.5%. That said, it now seems unlikely that American will reach the high end of that range. Furthermore, it wasn't clear from the company's guidance update whether the maintenance costs saved last quarter will just be shifted to later periods.
American is feeling the heat from United Airlines' growth
In its recent investor update, American Airlines disclosed that last quarter's unit revenue shortfall was driven by lower domestic airfares. Investors will have to wait for American's earnings report for more details, but this would be in line with the company's recent trajectory. Domestic passenger revenue per available seat mile increased 3.5% in 2017 -- including a 5.7% increase in Q4 -- but rose just 2% in the first quarter.
It probably isn't a coincidence that this slowdown corresponds to an uptick in capacity growth at United Continental (NYSE:UAL), which competes in many of the same markets as American. Domestic capacity is up 6.4% year to date at United Airlines.
United is in the midst of a multiyear plan to expand faster than the market. Management expects this initiative to reduce unit costs while also boosting unit revenue in the long run by improving the carrier's ability to serve small cities, where fares tend to be higher. As long as United sticks to this plan, American Airlines will have trouble accelerating its domestic unit revenue growth.
Is United also experiencing unit revenue pressure?
While oil prices have pulled back this week, airlines are still facing massive year-over-year fuel cost increases. This makes it more important than ever for airlines to achieve strong unit revenue gains, which will be difficult if the market is oversupplied.
Many airlines have announced plans to trim capacity after the summer peak season. However, the critical question for American Airlines is whether United will follow suit. United Airlines' most recent guidance calls for full-year capacity growth of 4.5% to 5.5%, which actually implies faster expansion in the second half of the year. (United's total capacity is up 4.2% year to date.)
The only thing likely to divert United Continental from its growth plan is a unit revenue miss that leads to an unacceptable level of margin erosion. United hasn't updated its initial Q2 guidance, which called for 1% to 3% passenger unit revenue growth. Thus, investors won't find out how it's doing relative to expectations until the company reports earnings next week.
American Airlines investors need to hope that United Airlines is facing just as much pain as its biggest rival. If not, United is likely to continue expanding rapidly, keeping the pressure on American Airlines for the foreseeable future.