On Thursday, American Airlines (NASDAQ:AAL) reported a small pre-tax profit for the second quarter -- thanks to the $1.4 billion of government payroll-support grants that it booked for the quarter. Returning to profitability under any terms represents a step in the right direction for the struggling airline giant.
Nevertheless, American Airlines continues to post poor results by any objective standard. Moreover, its long-running margin deficit, compared to the rest of the industry, remains firmly intact.
Earnings underperformance continues
American Airlines' revenue surged 87% sequentially last quarter and more than quadrupled year over year, reaching $7.5 billion. That said, the carrier generated $12 billion of revenue in the same period two years ago.
Management noted that American Airlines has consistently generated higher unit revenue than fellow full-service carriers Delta Air Lines (NYSE:DAL) and United Airlines (NASDAQ:UAL) in recent quarters. However, this hasn't translated to stronger earnings.
Excluding special items such as government payroll-support grants, American recorded a pre-tax loss of $1.4 billion in the second quarter, putting its adjusted pre-tax margin at negative 18.8%. This beat United's ugly $1.6 billion adjusted pre-tax loss (equivalent to a negative 29.2% adjusted pre-tax margin). That said, American Airlines benefited from favorable geography, as its route network has historically focused much more on domestic travel and the fast-recovering Sun Belt region than United.
On the other hand, industry-leader Delta continues to outperform American Airlines by a wide margin. Earlier this month, it reported a Q2 adjusted pre-tax loss of $881 million, giving it a negative 13.9% adjusted pre-tax margin.
Recent trends set to continue
For the third quarter, American Airlines expects the revenue recovery to continue, with revenue down approximately 20% from 2019 levels on 15% to 20% less capacity. This implies a very small decline in unit revenue.
However, American expects nonfuel unit costs to rise 8% to 12%, compared to Q3 2019. Fuel prices are also on track to increase somewhat. Additionally, the company projects that non-operating expense will reach $385 million -- up from $251 million in Q3 2019 -- due to increased interest costs. As a result, American Airlines' forecast calls for continued losses this quarter, with an adjusted pre-tax margin between negative 3% and negative 7%.
By contrast, Delta Air Lines and United Airlines plan to implement bigger capacity reductions relative to the third quarter of 2019. Consequently, they expect to report deeper revenue declines. Nevertheless, both companies' outlooks call for positive adjusted pre-tax income in the third quarter (and in the fourth quarter, for that matter). In short, American Airlines' margin deficit compared to its top rivals is growing, not shrinking.
Serious structural problems
In recent years, management has implemented a variety of initiatives to improve American Airlines' profitability. For example, the company has expanded its gate space at its three most profitable hubs: Dallas-Fort Worth, Charlotte, and Washington, D.C.'s Reagan Airport. It has adopted new standard layouts that increase seating capacity on most of its domestic mainline jets. And American has retired several less-efficient, subscale fleet types since 2019, thereby simplifying its fleet.
However, the airline has remained committed to all of its other hubs, which collectively were barely profitable (at best), even before the pandemic. It can't exit those markets without risking the loss of big corporate contracts to Delta and United. But with the airline industry getting steadily more competitive, bringing those markets to profitability will be tougher than ever in the years ahead.
Making matters worse, American Airlines has by far the worst balance sheet of any U.S. airline. It ended the second quarter with $40 billion of debt, plus $8.3 billion of lease liabilities and $6.6 billion of pension and other retirement obligations. As a result, it spends significantly more than rivals on interest and aircraft rent.
With American Airlines' weak profitability likely to continue for the foreseeable future, long-term investors should probably put their money elsewhere.