Last week, American Airlines (AAL -1.77%) reported record revenue and a record operating profit for the second quarter of 2023. The airline giant also raised its full-year earnings guidance.
Nevertheless, American Airlines stock fell 6% after the earnings report on Thursday and has fallen further in recent days. While the Q2 results were quite strong, investors are rightfully worried about whether the company can sustain its recent profit surge. Let's take a look.
American delivers a strong quarter
Like most other major U.S. airlines, American Airlines' revenue is reaching new heights in 2023. American and its peers have restored capacity to around pre-pandemic levels, while unit revenue remains near historical highs due to strong demand and industry-wide supply constraints.
Last quarter, American Airlines posted revenue of $14.1 billion, up from $13.4 billion a year ago and just $12 billion in Q2 2019. Unit revenue dipped a modest 0.5% year over year. That easily beat the company's late May forecast of a 1% to 3% decline in that metric (not to mention its original guidance, which called for a 2% to 4% drop).
Meanwhile, American's average jet fuel price fell 35% year over year. The resulting savings caused American's Q2 adjusted operating margin to double to 15.4% from 7.5% a year ago. Second-quarter adjusted operating income set a record at $2.2 billion, beating the previous high of $2.1 billion reached in Q2 2015.
Adjusted earnings per share reached $1.92, blowing past the company's updated guidance range of $1.45 to $1.65. That gave management the confidence to lift the full-year adjusted EPS forecast from $2.50 to $3.50 to a new range of $3.00 to $3.75.
Wobbly guidance
While these Q2 results seemed to point to American Airlines entering a new boom period, the outlook for the rest of the year painted a different picture. Management projects that unit revenue will fall 4.5% to 6.5% in the third quarter, due to tougher year-over-year comparisons.
Image source: American Airlines.
This will constrain profitability, despite another quarter of modest unit cost inflation and lower fuel costs. American Airlines is calling for an adjusted operating margin of 8% to 10% this quarter. That's still better than the Q3 2022 result of 7.2%, but such a sharp sequential decline from the second quarter to the third quarter is very atypical. American's biggest rivals are anticipating much stronger margins this quarter.
Management struck a confident tone during the company's earnings call, directing investors' attention to the increased full-year earnings guidance. Yet the full-year guidance didn't rise as much as American Airlines' earnings exceeded its previous projections. In short, management's outlook for the second half of the year appears to be worsening (at least marginally).
Plenty of reasons for concern
Of course, it's possible that management is just being very conservative with its guidance. If American Airlines continues smashing its earnings forecasts, the stock -- which trades for just 5 times the company's projected 2023 earnings -- could rally again.
However, with the highest debt load in the U.S. airline industry, American Airlines doesn't have much room for error. Despite making progress on shoring up its balance sheet over the past two years, the company still has nearly $43 billion of debt and lease liabilities.
As lower-fare airlines address their pilot attrition and begin to ramp up growth, unit revenue pressure could continue. On the cost side, fuel prices are starting to creep up again, and American Airlines hasn't yet felt the full impact of giving huge raises to its own pilots. These trends could further compress margins for American, which has historically been less profitable than most of its peers.
In short, American Airlines isn't well positioned for the possibility of margin pressure. The shaky third-quarter guidance could just be a blip, but it could also be a canary in the coal mine for the company. There's no good reason to own American Airlines stock in the face of this uncertainty when there are much stronger alternatives in the U.S. airline industry.
