October 15, 2014 / 6:18 PM / 3 years ago

Airlines to report strong third quarter earnings despite stock drop: analysts

Customers wait their turn to be served in a line at the Delta airlines office in Caracas July 7, 2014. REUTERS/Carlos Garcia Rawlins

(Reuters) - U.S. airlines are expected to report healthy third-quarter profits as jet fuel costs keep declining, even though their stocks have plunged on concerns that Ebola will discourage travel, analysts said.

Delta Air Lines (DAL.N) kicks off earnings season Thursday with what is expected to be a stronger performance than in 2013. Earlier this month, the airline projected a quarterly operating margin of 15 to 16 percent, excluding one-time charges that would cut these numbers in half.

Yet rather than applaud any third-quarter gains, investors will focus on whether the current-quarter outlook has darkened because of renewed competition and macroeconomic concerns such as Ebola.

Shares of Delta, American Airlines (AAL.O) and United Airlines (UAL.N) have dropped more than 18 percent on average in the last month on fears that people will cut travel to reduce the chance of catching Ebola.

Analysts say positive guidance coupled with jet fuel savings could reverse the stocks’ downward trend.

The stocks “have been very, very weak, but there’s no reason for them to be,” said Cowen & Co analyst Helane Becker. “We think that guidance for the fourth quarter is likely to be up, not down.”

Buying American Airlines shares now almost guarantees gains, according to a JPMorgan report by analyst Jamie Baker published Tuesday. The stock’s value has fallen 30 percent in the last 30 trading days. When shares of Continental Airlines and post-merger United have fallen by 30 percent, which has happened 28 times since 1993, they rebounded with an average gain of about 103 percent, Baker wrote.

FUEL SAVINGS

Jet fuel, which represents 35 percent of U.S. airlines’ operating costs, has fallen about 12 percent over the past month to levels unseen since 2010, Becker said.

The savings go straight to American’s bottom line because it does not hedge fuel costs. But other carriers likely will see smaller potential gains.

A Trefis report anticipated that Delta will incur $350 million in charges this quarter from fuel hedge settlements. Southwest Airlines (LUV.N) said in an interview earlier this month that it is hedging less, though still actively managing fuel costs.

Cheaper fuel usually leads to lower airfares and passenger revenue, Becker and UBS analyst Darryl Genovesi said. So the amount of fuel savings that airlines actually will keep remains in question.

“We’re in a period of elevated macroeconomic uncertainty, so there is some concern that the airlines will see declining unit revenues,” Genovesi added, citing the potential for slowing global economic growth, crises in the Middle East and Ukraine, as well as to Ebola.

Still, Genovesi expects a modest rise in unit revenue, or passenger revenue per available seat mile, in the fourth quarter. Despite Ebola fears, holiday travel bookings data through Oct. 5 suggest demand is close to unchanged from last year. But “it is certainly possible that demand has deteriorated over the past 10 days,” he said.

COMPETITION AND SURPRISES

Investors also will scrutinize airlines’ recent moves into new markets. Delta has announced nine daily flights from Los Angeles to Texas, continuing the Atlanta-based carrier’s incursion into strongholds of American Airlines.

Fort Worth-based American has since unveiled nonstop service between Los Angeles and Delta’s Atlanta home.

If “new flights are being added purely for reciprocation” rather than for expected profit, that is “something we’d prefer not to see,” Genovesi said.

United and Southwest offer the biggest potential earnings surprises. Considered a “laggard” in previous quarters, United recently revised its forecast for this quarter’s passenger revenue per available seat mile to the upper limit of its original estimate, making it an industry leader by that measure, said consultant Robert Mann and Becker.

Southwest is expected to gain from aggressive route expansion. It now can fly nonstop from Dallas Love Field to anywhere in the lower 48 states after a state statute banning such flights expired Monday.

Southwest also is adding international destinations and transcontinental routes after regulators approved the American-US Airways merger on the condition that they open up slots at New York LaGuardia and Washington DC Ronald Reagan airports for other carriers.

Reporting by Jeffrey Dastin; Editing by Alwyn Scott and Richard Chang

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