Why Southwest and American Airlines Shares Are Crashing

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American Airlines Group Inc. (NASDAQ: AAL) and Southwest Airlines Co. (NYSE: LUV) both saw their shares fall early on Thursday after each reported less than spectacular earnings. Airlines have been in the limelight lately, with the social backlash to the United Continental incident of dragging a passenger off a plane and American Airlines staff instigating passengers.

It seems that the drops that American and Southwest saw were more driven by financials than social justice. Even though Southwest hit a record revenue in its first quarter, this was still not enough to balance out the rising costs in the field. The same story seems to be true for American as well.

When American reported its most recent quarterly results before the markets opened, the company said that it had $0.61 in earnings per share (EPS) and $9.6 billion in revenue. Consensus estimates from Thomson Reuters had called for $0.55 in EPS and revenue of $9.6 billion. The first quarter of last year reportedly had EPS of $1.25 and $9.44 billion in revenue.

Total first-quarter operating expenses were $9.0 billion, up 11.4% year over year, due primarily to a 37.8% increase in consolidated fuel expense. Total first-quarter cost per available seat mile excluding fuel and special items was 11.16 cents, up 7.6% year over year, due primarily to a 6.5% increase in salaries and benefits expense and other investments to improve the operation.

American plans to invest $4.1 billion in new aircraft this year, as it continues to renew its fleet. During the quarter, the company invested $1.2 billion as it took delivery of 17 mainline aircraft and five regional aircraft.

Also in an unprecedented step, the company will increase the hourly base pay for its crew members outside of contract negotiations, bringing those workgroups’ base pay levels to the top of the industry, consistent with other workgroups within the company.

Southwest reported $0.61 in EPS and $4.9 billion in revenue for the first quarter. The consensus estimates were EPS of $0.63 and $4.92 billion in revenue. In the same period of last year, it posted $0.88 in EPS and revenue of $4.83 billion.

First quarter 2017 total operating expenses increased 8.8% to $4.2 billion, and increased 4.5% on a unit basis, as compared with first quarter of 2016.

Gary C. Kelly, board chair and chief executive, further explained the record revenues and then the increasing costs:

Total operating revenues were a first quarter record $4.9 billion. We carried a record number of passengers for any first quarter on 2.3 percent more trips, year-over-year. As expected, first quarter operating unit revenues (RASM) declined, year-over-year, due largely to the competitive fare environment and shift in Easter travel demand. Year-over-year RASM trends in April have turned positive, even excluding an approximate $10 million Easter benefit. Based on current bookings and revenue trends, we expect second quarter 2017 RASM to increase in the one to two percent range, year-over-year, which is notable considering our year-ago RASM growth and industry outperformance.

Our first quarter unit cost inflation was driven primarily driven by higher fuel costs and pay increases from amended union contracts. Costs associated with our operational initiatives and upcoming implementation of our new reservation system also contributed to our first quarter cost pressures. Our cost inflation is expected to abate dramatically in second half 2017 to end this year with fourth quarter unit costs in line with year-ago levels, excluding fuel and oil, special items, profit-sharing, are estimated to increase approximately 3%, year over year, unchanged from prior expectations.

Shares of Southwest were down 2.6% just after the opening bell at $55.42, with a consensus analyst price target of $62.87 and a 52-week trading range of $35.42 to $56.68.

American Airline was trading at $42.95, down 7.4%, with a consensus analyst price target of $54.73 and a 52-week range of $24.85 to $50.64.