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American Airlines Raises Guidance Despite 737 MAX Hit

Adam Levine-Weinberg, The Motley Fool

Last week, Delta Air Lines boosted its second-quarter guidance, assisted by the grounding of the Boeing (NYSE: BA) 737 MAX. 737 MAX operators like American Airlines (NASDAQ: AAL) and Southwest Airlines (NYSE: LUV) have been forced to cancel more than 100 flights a day due to having dozens of aircraft out of service. That's leading to packed planes and higher fares for air travel, particularly in the domestic market.

The Boeing 737 MAX grounding and the resulting capacity constraints may even be helping some 737 MAX customers. On Wednesday morning, American Airlines lifted its guidance for the second quarter, notwithstanding the impact of the 737 MAX grounding.

A rendering of an American Airlines jet parked on the tarmac.

American Airlines boosted its second-quarter RASM forecast this week. Image source: American Airlines.

Unit revenue growth firms up

In late April, American Airlines projected that revenue per available seat mile (RASM) would increase 1% to 3% in the second quarter. That would have represented a solid acceleration in its unit revenue momentum after RASM inched up just 0.5% year over year in Q1.

At the time, management warned that the carrier's flight cancellations wouldn't necessarily boost RASM. While slower capacity growth is usually positive for unit revenue, American Airlines executives stated that the last-minute nature of some of the flight cancellations meant that the airline would have fewer seats available for lucrative close-in bookings.

However, it looks like management exaggerated the impact of this issue. American Airlines now expects to report a 3% to 4% RASM gain for the second quarter, exceeding the high end of its initial guidance range. The carrier raised its unit revenue outlook despite cancelling even more flights than expected -- due in part to rising labor tensions involving its mechanics -- and falling short of its target for cargo revenue by $35 million.

American Airlines avoids a big unit cost spike

Southwest Airlines, which has the largest 737 MAX fleet in the world (and thus had to cancel the most flights over the past few months), is on track to report an even bigger Q2 unit revenue increase. Last month, the low-fare carrier estimated that RASM would rise 6.5% to 7.5% for the quarter. However, Southwest also expects nonfuel unit costs to surge 11.5% to 12.5% year over year, due in large part to the volume of flight cancellations. This will severely constrain Southwest Airlines' profitability for the second quarter.

By contrast, American Airlines did a pretty good job of managing its costs last quarter despite the wave of flight cancellations. Nonfuel unit costs are on track to rise 4.5% to 5.5% year over year.

On the flip side, American reduced its fuel cost guidance by $0.02 per gallon in its investor update this week. It now expects to report fuel costs between $2.12 per gallon and $2.17 per gallon for the second quarter, down from $2.24 per gallon a year ago.

The net result is that American Airlines was able to raise its adjusted pre-tax margin forecast from a range of 7% to 9% previously to a new range of 8.5% to 9.5%. Its adjusted pre-tax margin in the prior-year period was 8.6%. Based on the midpoint of this new guidance range, American's EPS will come in around $1.83 for Q2, up from $1.63 a year ago and well ahead of the average analyst estimate of $1.69.

A good sign for the third quarter

The Boeing 737 MAX grounding is likely to continue well into the fall, causing capacity to decline again at American Airlines and Southwest Airlines during the third quarter. However, American's solid Q2 results show that this isn't a very big problem for the carrier.

After all, American Airlines is poised to report a double-digit increase in EPS for the second quarter, despite an estimated $185 million pre-tax profit headwind related to the grounding. In reality, the unit revenue benefit of restraining capacity may be offsetting the costs of the 737 MAX grounding. Moreover, the carrier may receive compensation from Boeing at some point down the line, most likely through discounts on future aircraft purchases.

For the third quarter, American adjusted its flight schedule further in advance, giving it more of an opportunity to optimize its revenue management and cost structure. This could lead to even greater margin expansion -- and another earnings beat -- in the quarter ahead. With American Airlines stock trading at a very modest valuation, that could send the shares soaring in the coming months.

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Adam Levine-Weinberg owns shares of Delta Air Lines and Southwest Airlines and is long January 2020 $20 calls on American Airlines Group. The Motley Fool owns shares of and recommends Delta Air Lines and Southwest Airlines. The Motley Fool has a disclosure policy.