Southwest Airlines (NYSE: LUV) and United Continental (NYSE: UAL) disappointed investors in October with their third-quarter earnings reports and fourth-quarter forecasts. While both carriers projected that their unit revenue trends would improve sequentially in the current quarter, analysts still had to slash their Q4 earnings estimates.
However, Southwest and United both raised their unit revenue forecasts late last week. This suggests that the recent round of airline fare wars may be abating, which would be good news for American Airlines (NASDAQ: AAL) and Delta Air Lines (NYSE: DAL) as well.
Southwest Airlines has boosted its fourth-quarter unit revenue forecast. Image source: Southwest Airlines.
Resetting investors' expectations
Unit revenue fell at Southwest Airlines and United Continental last quarter. United posted a particularly poor performance, with passenger revenue per available seat mile (PRASM) down 3.7% year over year. The two carriers reported facing a variety of unusual revenue headwinds, including the negative impact of Hurricane Harvey on travel demand in the Houston area.
At the time of its Q3 earnings report, Southwest projected that unit revenue would return to growth this quarter, rising as much as 1.5%. On the other hand, the company acknowledged that unit costs would likely be higher than previously expected in the fourth quarter. Meanwhile, United Continental estimated that PRASM would retreat by 1%-3% in the fourth quarter, leading to another steep margin decline. Furthermore, management didn't offer investors any comfort that the company's profit margin would improve in 2018.
As a result, shares of both companies fell significantly following their respective earnings reports in mid-late October.
Southwest Airlines and United Continental stock performance. Data by YCharts.
By contrast, American Airlines and Delta Air Lines posted more promising earnings results. Delta reported that PRASM increased 2.7% last quarter and projected that PRASM will rise 2%-4% in Q4. American saw a 1.1% increase in total revenue per available seat mile (RASM) in Q3 and expects to report a 2.5%-4.5% RASM gain in Q4.
The outlook isn't so bad, after all
Last Thursday, Southwest Airlines raised its Q4 unit revenue guidance. It now projects that RASM will increase 1%-2% this quarter. A day later, United Continental followed suit. United now expects PRASM to decline 0%-2% in the fourth quarter: 1 percentage point better than its initial forecast.
Neither carrier offered any details about what is driving the better-than-expected revenue results. One possibility is that the improvement is largely concentrated in Houston, where United and Southwest are the two largest airlines by far. An uptick in oil prices in the past two months may have accelerated the post-Hurricane Harvey economic recovery there.
The other possibility is simply that the vicious fare wars that broke out this summer have started to abate. This would be a very good sign for the rest of the airline industry. Travel demand has been strong all year, so there was never a rational reason for such extensive discounting.
Unit revenue growth is critical for airlines' health now
The improving unit revenue outlook -- at least for Southwest Airlines and United Continental -- has come not a moment too soon. The increase in their unit revenue forecasts has done no more than offset the recent rise in fuel prices, which will drive up their unit costs.
Indeed, achieving solid unit revenue growth will be critical for airlines in 2018. Barring another collapse in oil prices, most airlines will need unit revenue increases of 3% or more next year just to keep their profit margins stable.
Investors will get another look at industry unit revenue trends later this week, when Delta Air Lines holds its annual investor day. Delta's management commentary will likely reveal whether the strengthening unit revenue trends at Southwest and United are part of a broader upswing.
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