American Airlines (AAL 1.73%) investors have endured lots of disappointment over the past several years. They have faced more of the same in 2019, with labor strife and the grounding of the Boeing (BA 0.02%) 737 MAX weighing heavily on the company's profitability. Whereas American Airlines entered the year expecting to produce adjusted earnings per share between $5.50 and $7.50, analysts now expect EPS to come in around the $5 mark.
Fortunately, American Airlines did offer some good news in an investor update posted last week. The airline giant said that it expects its third-quarter pre-tax margin to reach the upper half of the guidance range it had provided in late July. This suggests that American finally may be close to stabilizing its business.
Management nudges guidance higher
Back in July, American Airlines projected that revenue per available seat mile (RASM) would rise 1% to 3% in the third quarter, roughly in line with the 2.1% RASM gain it achieved in the first half of the year. Meanwhile, the company said that adjusted nonfuel unit costs would rise 4% to 6% year over year, partly because it was forced to reduce its capacity growth due to the Boeing 737 MAX grounding. Lower fuel prices are offsetting some of this cost pressure.
Factoring in all of those elements, American's initial forecast called for a Q3 pre-tax margin between 5.5% and 7.5%. For comparison, the carrier posted a 6% pre-tax margin in the prior-year period.
Last Wednesday, American narrowed its revenue guidance range. It said that RASM rose 1.5% to 2.5% last quarter, despite the negative impact of Hurricane Dorian, which hit Florida on Labor Day weekend. The company left its nonfuel cost guidance intact and reduced its fuel cost estimate by $0.02 per gallon. As a result, American Airlines now expects its adjusted pre-tax margin to come in between 6.5% and 7.5% for the quarter.
Boeing 737 MAX grounding costs continue to rise
American Airlines had to cancel 9,475 flights last quarter, due to the grounding of its 24 Boeing 737 MAX 8s and the delayed delivery of the 16 additional 737 MAX jets it was supposed to receive in 2019. The company estimates that this reduced its pre-tax profit by about $140 million last quarter. This brings the running tally of the 737 MAX grounding's cost to $395 million.
Additionally, the airline pushed back its estimate for the Boeing 737 MAX's return to service to Jan. 16, 2020. That means it will be forced to run a reduced schedule during the busy Thanksgiving and Christmas travel periods.
Thus, investors should expect another big earnings hit in the fourth quarter from the 737 MAX grounding, particularly because the carrier retired all of its remaining MD-80s last month. This will likely push the full-year pre-tax cost of the grounding beyond $500 million, compared to the airline's most recent estimate of $400 million.
What the update means for investors
The Boeing 737 MAX grounding negatively impacted American Airlines' pre-tax margin by a little more than 1 percentage point last quarter. However, even adjusting for that headwind, the company would have posted a single-digit pre-tax margin in what is typically one of the most profitable parts of the year. This highlights American's continuing underperformance within the U.S. airline industry.
Nevertheless, it's encouraging that American Airlines was able to improve its quarterly earnings guidance even though Hurricane Dorian impacted one of its hubs on a busy travel weekend. The carrier's effort to expand at its highly profitable hub in Dallas-Fort Worth seems to be succeeding. This bodes well for American's plan to grow in Charlotte and Washington, D.C. -- its other two most-successful hubs -- over the next two years.
The Boeing 737 MAX should be able to return to service early next year, enabling American Airlines to get back to a fairly normal schedule in time for the peak spring and summer travel seasons. This should lead to better unit cost performance beginning next year. The airline is also in line to receive compensation for its losses from Boeing, which will provide an earnings boost in the future.
American Airlines is still a long way from matching its peers in terms of profitability. However, investors can at least take comfort that it is starting to move in the right direction -- and the return of the Boeing 737 MAX next year could be the spark needed to accelerate the company's earnings growth.