Reopening, low base effect to drive revenue surge at US airlines in Q2 – Stock Market News

Airlines will dominate the US earnings calendar this week and following Delta Air Lines’ impressive results last Wednesday, hopes are high that the industry can return to profit in a post-pandemic world. United Airlines will be the first to report on Tuesday after the close of trading, while American Airlines and Southwest Airlines will both announce their results before Wall Street’s opening bell on Thursday. After a strong year-long rally that lasted till April, airline stocks have since been trending downwards. Is the cyclical boom over for airlines or do Q2 earnings have something more to deliver other than the expected boost from the economic reopening?

Reaping the benefits of the reopening

There can be no doubt that the past year and a half has been crippling for the travel industry and even more so for airlines as international travel restrictions remain in place in most countries. In the United States, where airlines can rely on the domestic market for the bulk of their revenue, the recovery from the depths of the pandemic slump has come a long way.

Daily new infections in the US have declined to their lowest in more than a year and the country also boasts a high vaccination rate. Life is seemingly returning to normal with virus curbs all but gone in most states. This is spurring Americans to move around more and book flights once again, whether for business or pleasure.

Has Delta’s impressive earnings set the trend?

Delta Air Lines, which reported its Q1 results last week, returned to profit for the first time in six quarters and saw its revenue soar 385% year-on-year to $7.1 billion. This was, however, still down 43% from the same quarter in 2019, highlighting how the recovery is far from complete. And this is where investors are having a hard time being positive about the outlook.

Just as Covid-19 jabs came into the picture and the big nations moved fast to get their populations immunized, a new more dangerous variant has emerged, which is not only extremely contagious but the current vaccines are proving to be less effective against it. The delta strain is now rampant in most parts of Asia and Europe and could soon be sweeping across the US as well. While vaccines still offer a good degree of protection and should prevent the need for draconian social distancing rules to be reinforced, the negative development does nevertheless make it unlikely that travel restrictions will be completely relaxed anytime soon.

Worries about future revenue growth

That doesn’t bode well for future revenue as once passenger numbers reach the limit that is sustainable under the current pandemic backdrop and the low base effect from 2020 eventually drops out of the year-on-year comparison, it’s difficult to see where the growth will come from. In addition, going forward, airlines will no longer be able to rely on generous government aid in the form of the Payroll Support Program to ease the burden on cash flow.

To top it all off, oil prices have continued their strong gains this year, and although the rally could be easing, higher fuel costs at a time of crisis for the industry simply add another headache for airline bosses.

As seen from the market reaction to Delta’s results, the gains on the back of the better-than-expected earnings were short lived, with the stock price resuming its downtrend the following day. The earnings of United, American and Southwest will probably be greeted similarly should they beat the estimates.

Triple digit jump in revenue expected

According to Refinitiv IBES, United is expected to report revenue of $5.37 billion in Q2 – a 264% y/y increase, while earnings per share (EPS) are anticipated to improve to a loss of $3.85 compared to a loss of $9.31 in Q2 2020. American Airlines’ revenue is estimated at $7.43 billion, up from just $1.62 billion a year ago. Its EPS is also projected to remain negative, at $-1.79 despite representing an annual growth of 77%. Finally, Southwest is expected to report revenue of $3.93 billion in Q2, an almost fourfold improvement over Q2 2020’s figure of $1.01 billion, and EPS of $-0.22, up from $-2.67 in the corresponding period.

However, with market fears about the delta variant deepening in recent days, upbeat earnings might not be enough to lift their share price even in the short term. The challenge for reopening stocks such as airlines is that they peaked even before the latest virus scare, as the next phase of their rally depended on a full global economic rebound coming much closer within sight. The delta outbreak makes that reality less likely.

It might not be all gloom

But there is still some hope for the industry, particularly in the US where demand for domestic leisure travel has been rising solidly and could continue to strengthen even if the virus situation deteriorates in other parts of the world. Another cause for optimism is that international travel restrictions have yet to be eased substantially in spite of the progress in vaccinations so should that change, there is room for further growth even in the present virus settings.

President Biden is under pressure from multiple sides to lift the ban on international travellers visiting the US. Europe recently opened its doors to Americans and Biden is expected to return the favour soon. Transatlantic travel with the help of vaccine passports could be just what the airlines need to survive during this pandemic as government support and the initial reopening boost dwindle.

Mixed fundamentals

That optimism might explain why analysts still have a hold or buy rating for the big US airlines, though it’s worth noting that United stock was recently downgraded from ‘buy’ to ‘hold’ and only Southwest and Delta have maintained a ‘buy’ recommendation. As for their forward multiples, unsurprisingly, it is Southwest and Delta again that have a positive 12-month price/earnings (PE) ratio, with American and United Airlines both having negative forward PEs.

Heading into the earnings calls, traders should keep an eye on the guidance for Q3 as well as any updates on how the airlines plan to cut costs, as any positive surprises on these fronts could be a trigger for an upside correction in the stocks.


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