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American Airlines cut its estimates for full-year earnings-per-share on Thursday, spooking investment analysts who wondered why the carrier has no plans to sell fewer seats later this year to try to boost pricing power.
That was the theme of American’s first quarter earnings call, after the airline slashed its per share earnings guidance by 50 cents. The reason is fuel prices that have increased more than 60 percent since last summer, and by 12 percent just in the past two weeks, CEO Doug Parker said. Oil prices were trading at about $68 per barrel in New York on Thursday. Last June, they were as low as $44.83.
The company expects to pay roughly $2.3 billion more in fuel this year than in 2017, and while some of that is because American is flying more, most of it comes from higher prices. “That kind of an increase … is going to have an impact on airline financials,” Parker said. After his comments, American’s stock fell, and it was down roughly 5 percent by 1 p.m. in New York.
Airlines have been through these cycles before, and analysts know there’s generally two ways to fix profit pressures that may come next. Airlines can increase prices on existing capacity, which can be hard to do, because customers get accustomed to cheap prices and may not want to pay more, or they can cut the number of seats they offer to force higher prices. They can also try both approaches.
But for now, Parker said American is not planning any drastic changes. It still plans to grow capacity 2.5 percent year-over year, calculating it makes no sense to slash seats with American’s most profitable season is approaching. But Parker said he expects all airlines will examine their capacity levels if they expect fuel prices will continue to rise. Perhaps, he said, airlines will not reduce the number of seats they sell, but they might grow by less than planned.
“We’re somewhat surprised that capacity reductions weren’t made …, but understand that oil prices have been fairly volatile recently,” Joseph DeNardi, an analyst with Stifel, said in a research report. “We see American, and its peers, responding to higher oil prices by reducing capacity as a positive catalyst over the next few months to improve what has quickly become pretty negative sentiment toward the group.”
Parker, not surprisingly, spun higher fuel prices as a positive for American. Its costs for almost everything are higher than for ultra-low-cost-carriers, but all airlines tend to pay the the same price for fuel. As a result, more expensive fuel can disproportionately hurt discount carriers such as Spirit Airlines and Frontier Airlines.
“The one good thing, I guess, about higher fuel prices, is it affects everybody,” Parker said. “So as fuel prices have increased, their costs increase at a rate greater than rest of us.”
Over time, Parker said, ticket prices may increase as airlines try to recoup their higher costs. But that’s often not something that happens all at once, as airlines are a competitive business and it takes time for industry fares to rise as a group.
“As our cost of production goes up, the cost of travel should go up somewhat,” Parker said.
While analysts focused on fuel Thursday, most of the business is strong, executives said, American reported a first-quarter net profit of $186 million, and said passenger revenue per available seat mile, a metric that measures how much money American makes for each seat it flies one mile, increased 3 percent year-over-year.
It said passenger revenues were up in every geographical location, led by Latin America, where unit revenues increased 12 percent. “We are seeing strong demand for our product both domestically and internationally,” President Robert Isom said.
Despite the fuel price issue, Stifel’s DiNardi said he was surprised investors pushed the stock down on Thursday.
“We’re surprised by the stock performance today, and over the past few weeks, given valuation and free cash flow even with higher fuel,” he said.