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American Airlines shares (NYSE:AAL) have dropped by more than a quarter in the last two months.
But how can this be? Isn’t there a huge travel boom that is going to keep rocking forever and ever and ever? Yes there is, but the company isn’t exactly capitalising – in fact, an update from the company earlier this week reveals it is getting squeezed.
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Introduction to American Airlines
Before we go on, we need to outline the different market American Airlines (AA) is in compared to Qantas. The US aviation market is a lot more competitive with more airlines.
Most airlines operate a hub and spoke model, centred around transiting passengers between hubs rather than operating as many point to points as possible. So if you want to fly from Houston to Denver, you might be able to go direct on United, which counts both cities as hubs. But if you want to fly American, you have to go via one of their hubs.
AA has over half a dozen hubs, its largest is Dallas Fort Worth. This is why Qantas flies non-stop to Dallas from Melbourne and Sydney, because it serves nearly 200 destinations on direct flights from there.
American Airlines is the largest US airline by fleet, with over 900 aircraft. But just over 120 of these are widebodies (Boeing 777s and 787s to be specific). American Airlines doesn’t have the international network that United and Delta have and the airline is not as bold in terms of announcing new routes. This is not ideal right now because the US aviation market is seeing solid demand for international travel, particularly to Europe. But domestic travel demand is softening.
Why American Airlines shares are down right now
Less than 2 months ago, American gave Q3 guidance of:
- 85-95c per share EPS
- $2.55-$2.65 per gallon in fuel
- An 8-10% operating margin
But earlier this week it updated all these metrics. It is expecting:
- 25-35c EPS
- $2.90-$3 per gallon of fuel
- An 4-5% operating margin.
Now, American Airlines did not specifically say demand was falling. It admitted jet fuel prices were on the rise and its new contract with the pilots union would squeeze its profit. But investors suspect domestic travel demand is falling after Southwest (LUV) and Spirit Airlines (SAVE) both warned demand was dipping and were offering discounts for bookings between now and Thanksgiving.
Spirit specifically cut its revenue guidance from $1.3-$1.32bn to $1.245-$1.255bn and that its operating margin would decline 14.5-15.5% down from a 5.5-7.5% decline. Spirit is also suffering from an attempt to buy fellow low cost carrier JetBlue that the regulators are not happy with.
What might this mean for Australian airline investors?
Qantas shares might take a hit when we have at least a rough idea of the fine it’ll have to pay to the ACCC and compensation it’ll pay to its former baggage handlers. It is possible that at its AGM in November, it may provide a trading update warning of rising fuel costs or falling travel demand.
Even if it reports travel demand is continuing to be elevated, investors have despised falling margins in any industries – whether fast food, retail or healthcare. We don’t imagine it’d be any different for the Australian airline industry.
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