Pricier Fuel to Test Airline Profits

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U.S. airlines are aiming to convince investors that surging fuel costs won't knock a record stretch of profitability off course.
 Some investors say airlines won't be able to raise prices fast enough to cover a roughly 55% increase in fuel costs from a year ago. The NYSE Arca Airline Index is down nearly 13% this year while the S&P 500 is up 3.2%. They expect carriers to commit to schedule cuts to address the rising costs when they report quarterly earnings this month. Delta Air Lines is the first to report, on Thursday.
 “The first course of action may be to adjust their fall and winter schedule, while trying to raise fares in strong markets,” said Helane Becker, an analyst at Cowen & Co. “Delta has repeatedly hinted at this.”
 Delta declined to comment ahead of its earnings report. Executives have said higher fuel costs will factor into their capacity decisions after the peak summer travel season.
 “We've made money at fuel prices at $100 and we've made money at $40,” Delta Chief Executive Ed Bastian said recently at the National Press Club in Washington. “There's a resiliency and a stability to our business like never before.”
 By many measures, airlines should be Wall Street darlings. The industry notched a record eighth straight year of profits last year. A strong global economy is stoking demand for air travel. Global passenger traffic rose 6.1% in May from a year earlier, according to the International Air Transport Association.
 Delta said last week it expects unit revenue to be up as much as 5% over the prior year in the second quarter. Unit revenue is a measure of how much airlines make for each mile they fly a passenger. But other costs are rising, too. In addition to fuel, many airlines recently agreed to labor contracts that will see them pay more in wages and benefits.
 And a shakier forecast for geopolitics and international trade could hurt flight demand if companies cut back on business travel, analysts said.
 “You need to have higher fares to offset the higher fuel. To do that, either demand has to be strong enough to absorb the increase, or if it's not you need to not fly those unprofitable seats,” said Savanthi Syth, an analyst at Raymond James.
 United Continental Holdings Inc. and Delta have each said they are paying about $2 billion more for fuel compared with last year — pressuring profit margins. Delta cited rising costs in June as it cut profit expectations for the second quarter from $1.80 to $2 a share to a range of $1.65 to $1.75 per share.
 United earlier this year raised its earnings expectations for 2018 to $7 to $8.50 per share. Scott Kirby, United's president, said on May 30 that the airline can hit that target despite higher fuel costs.
 Most airlines have cut back on using derivatives to hedge against fuel-price increases, lowering their operational costs while oil prices stayed low and relatively steady.
 Higher fuel prices will test whether airlines can pass on rising costs to customers, said Philip Baggaley, managing director at S&P Global Ratings.
 But raising prices is easier said than done, said Bob Harrell, head of Harrell Associates LLC, a consulting firm that tracks airline pricing. His research shows that while airlines have raised fares in recent weeks, they still lag behind last year's levels.
 “What drives pricing is not what they're paying at the pump but the balance of supply and demand,” Mr. Harrell said. “It's very hard to get prices up if you're adding seats faster than you're adding passengers,” he said.
 Airlines have been dogged this year by concerns that they are adding seats too quickly. United rattled investors with plans to expand capacity by 4% to 6% a year for three years. In April the airline tightened growth plans to 4.5% to 5.5% this year, and some hope it will throttle back further.


Schedule cuts would be a way for carriers to address rising costs.

 

Rising Costs

Jet fuel prices have risen steeply since late June of last year.

Price of jet fuel


Weekly airfare change from a year earlier


Note: U.S. Gulf Coast kerosene-type jet fuel
Sources: Harrell Associates LLC (airfare); Energy Information Administration (jet fuel)

 

BY ALISON SIDER

 

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