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Shares of American Airlines (NASDAQ: AAL) fell over 9% yesterday after the company’s estimated profits for Q1 were lower than Wall Street estimates due to higher labor and fuel costs. Soon after the disclosure, shares of airline companies, including Delta Air Line (NYSE: DAL) and United Airlines (NASDAQ: UAL), fell by 2.4% and 6.5%, respectively.
The airline industry has been able to offset rising costs thus far by increasing fares in the face of growing global travel. However, concerns have arisen about the sustainability of consumer demand due to high borrowing costs, inflation, and job losses.
The announcement was made one day ahead of Delta Air Lines' (DAL) quarterly earnings report. In an interview, Delta’s CEO Ed Bastian stated that the airline intends to provide premium seating on all its aircraft starting in the summer as a precautionary measure against a potential economic downturn. He also mentioned that the airline aims to lure customers willing to pay more for a higher level of comfort beyond just a seat.
What is impacting the bottom line for AAL stock?
In January, American Airlines reported that its fuel prices had increased by almost 70%. Despite a broader economic slowdown in the United States, the industry has been able to survive, largely due to constrained airline capacity resulting from shortages of aircraft and spare parts.
American Airlines has indicated strong demand, with total revenue per available seat mile, which is a measure of pricing power, expected to rise by approximately 25.5% in the first quarter of the year compared to the same period last year.
However, the company's adjusted forecast for quarterly profit per share is between $0.01 and $0.05 per share, down from the previous estimate of near break-even and lower than analysts' expectation of $0.06 per share, according to Refinitiv data.
What next for American Airlines' stock price?
Investing in American Airlines stock and its peers remains a high-risk proposition due to the following reasons:
- Industry Risk: The airline industry is highly competitive, and its profitability can be impacted by various factors such as fuel prices, labor costs, and economic conditions. The industry has also been impacted by the COVID-19 pandemic, which led to reduced demand and increased costs.
- Financial Risk: American Airlines has a significant amount of debt, which can make it vulnerable to changes in interest rates and its ability to meet its debt obligations.
- Operational Risk: The airline industry is heavily regulated, and operational risks such as accidents, security breaches, and disruptions in the supply chain could adversely affect the company's operations.
Analysts tracking AAL stock expect sales to rise by 8.7% to $53.2 billion in 2023, while adjusted earnings might expand almost 400x to $2.39 per share. So, American Airlines stock is priced at 5.4x forward earnings, which is very cheap. It's also trading at a discount of 30% to consensus price target estimates.
The final takeaway
Throughout 2022, investors in the airline industry anticipated a drop in demand as post-pandemic travel levels normalized and the Federal Reserve implemented measures to cool the economy. While there has been no significant decline in demand thus far, rising costs continue to act as a headwind for American Airlines and its peers.
Nevertheless, risks persist, particularly as interest rates continue to rise. As earnings season approaches, investors will closely monitor management commentary on 2023 to gain insight into early bookings for the crucial summer travel season.
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