American Airlines' (AAL -0.80%) plan to achieve a step change in profitability in 2019 was dashed earlier this year, because of the grounding of the Boeing (BA 0.89%) 737 MAX. A spike in flight cancellations during the spring and summer -- related to an alleged slowdown by the company's mechanics -- also negatively affected the airline's profitability.
These factors continued to weigh on American's earnings last quarter. Nevertheless, the airline was able to achieve double-digit growth in adjusted earnings per share, thanks to a combination of solid unit revenue growth and lower fuel prices. And with the 737 MAX likely to return in early 2020, American Airlines should be able to maintain its earnings momentum next year.
Solid improvement in the third quarter
In the third quarter, American Airlines increased its capacity just 1% year over year, as the grounding of its 24 Boeing 737 MAX 8s forced it to trim its flight schedule. Revenue per available seat mile (RASM) rose 2% year over year. That matched the midpoint of the company's updated forecast but was near the high end of the guidance range it published in late July.
Meanwhile, adjusted nonfuel unit costs rose 4.8%, in part because of the airline's slower-than-planned capacity growth. Fortunately, American's average fuel price declined to $2.05 per gallon from $2.30 a year earlier, offsetting most of the nonfuel cost pressure.
The net result was that revenue reached $11.9 billion -- up 3% year over year -- and adjusted pre-tax margin improved to 7% from 6.2% in Q3 2018. That drove a 16% increase in adjusted pre-tax income, to $835 million. Share buybacks added to American's EPS momentum, causing adjusted EPS to surge nearly 20% to $1.42, just ahead of the average analyst estimate of $1.39.
The Boeing 737 MAX grounding reduced pre-tax profit by about $140 million last quarter, according to the company. That implies that American Airlines could have achieved 35% pre-tax income growth in the third quarter, absent fleet constraints.
The Q4 outlook is a little shakier
Looking ahead to the fourth quarter, earnings growth may slow. RASM is on track to rise 0% to 2%, compared with a 2% to 4% increase in adjusted nonfuel unit costs. Once again, moderating fuel prices should offset most of the nonfuel cost headwind.
Based on all of these factors, American Airlines expects to report an adjusted pre-tax margin between 5% and 7% for the fourth quarter. In the year-ago period, it posted a 5.8% adjusted pre-tax margin. If American's results reach the high end of its guidance range, the carrier would sustain a double-digit earnings growth rate this quarter. By contrast, the low end of the range would imply an earnings decline. Thus, there is a good deal of uncertainty baked into the company's forecast.
With the Boeing 737 MAX now out of service until January at the earliest, American Airlines reduced the high end of its full-year earnings guidance. Its official forecast now calls for adjusted EPS between $4.50 and $5.50, compared with $4.55 in 2018, and the final result is likely to come in quite close to the $5.00 mark.
2020 looks like it will be a much better year
While American Airlines is on track to post modest earnings growth in 2019 on a full-year basis, its results still lag those of its main rivals in the airline industry. It will take time to address all the factors behind this underperformance, but American has a good chance to make meaningful headway next year.
Assuming that the Boeing 737 MAX does return early in the year, American Airlines plans to expand capacity by about 5% in 2020. That will enable it to hold nonfuel unit costs roughly flat, excluding the impacts of any new labor deals. The reintroduction of the 737 MAX will also boost fuel efficiency.
This uptick in capacity growth is consistent with continued unit revenue growth. Notably, a lot of American's growth will come at its two largest hubs -- Dallas-Fort Worth and Charlotte, where the carrier earns above-average margins. In addition, American Airlines will cancel most of its flights to Tokyo's Narita Airport by the end of the first quarter, replacing them with two new daily flights to Haneda Airport, which is more centrally located -- and thus more popular with business travelers.
There will always be potential pitfalls that American Airlines will need to avoid. The airline's recent track record in this respect is quite poor. However, American has enough positive catalysts for 2020 that investors can be fairly optimistic about its prospects for the year ahead.