Airlines Report On Q1 Earnings by Frank Holmes

A recent Deutsche Bank AG (NYSE:DB) report projects a total airline industry first-quarter pretax profit of $3.5 billion, up from $700 million this time last year—a 400-percent improvement.

The bank estimates that nearly 110 percent of the earnings gain will derive from lower fuel prices. It states that “the industry over the past several years has demonstrated its ability to successfully offset most, if not all, of the rise in fuel expense via a combination of cost savings and various revenue initiatives.”

Looking ahead to the end of the year, Deutsche Bank sees airlines generating $24.7 billion in operating income, or the money that remains after certain operating expenses are paid such as research and development, wages, maintenance and the like.

As we all know, oil has fallen nearly 50 percent since last summer, and jet fuel prices have followed closely at its heels, declining to multi-year lows. According to the International Air Transport Association (IATA,) airlines worldwide are expected to spend $71 billion on fuel in 2015, a savings of $84 billion compared to 2014.

Efficiency Leading the Way

An important metric Deutsche Bank uses to illustrate that the industry is in expansion mode is operating margin, which measures a company’s efficiency in generating revenue. This figure tells you how much of each dollar earned the company keeps as profit after taxes. Generally speaking, the higher the number, the more efficiently the company is being run and the more capital it can use to pay down debt and return to investors in the form of stock buybacks and dividends.

Because of fuel cost savings, all 11 of the companies below are expected to increase margins by the end of 2015.

The carrier expected to see the greatest increase is Las Vegas-based Allegiant Air, the ultra-low-cost regional carrier that focuses on underserved cities. The company provides a “complete travel experience” that allows customers to book hotel stays and car rentals on top of flights.

Claiming the highest margins last year was Spirit Airlines (SAVE), the carrier known for its “Bare Fare” pricing structure. Even though it offers some of the lowest prices in the industry—they’re 40 percent lower than the competition on average—Spirit is able to maintain these margins because of its stripped-down, no-frills service and experience.

Spirit certainly has grounds to justify this highly-frugal business model. In a June 2014 survey, close to 1,500 air travelers were asked what they considered first when looking to purchase an airline ticket. Fifty percent of respondents cited price as the most decisive factor, whereas only 3 percent said it was legroom.

Earnings Season

A few airlines have already reported on first-quarter earnings, and so far most have beaten analysts’ expectations.

American Airlines (AAL), which was recently added to the S&P 500, reported a record net profit of $1.2 billion, or $1.73 per share. This is a tripling of the carrier’s net profits in the first quarter of last year.

American CEO Doug Parker is so bullish on his company that he has asked to be compensated solely in company stock going forward.

Delta (DAL), which we own in our Holmes Macro Trends Fund (MEGAX), reported higher-than-expected earnings—$0.45 per share—with an average beat of 5.11 percent over the last four quarters. This marks the company’s eighth consecutive quarter of record profits.

Alaska Air’s (ALK) EPS came in at $1.12, with earnings up 75 percent on a year-over-year basis. The company reported record first-quarter net income of $149 million, a 67-percent increase from last year. During the quarter, the company also bought back $102 million worth of common stock and paid a $0.20 per-share dividend.

We own Alaska Air in MEGAX.

Southwest (LUV) reported record profits of $453 million—or $0.66 per share, beating consensus by one penny—up from $152 million in the first quarter last year.

United Continental (UAL) reported record first-quarter profits of $582 million, earning $1.52 per share, beating estimates of $1.44. The company paid back $200 million to shareholders in its proposed $1 billion share buyback program.

Finally, Allegiant (ALGT) also posted a record quarterly EPS of $3.74, up from $1.86 last year. This marks the ultra-low-cost carrier’s 49th consecutive profitable quarter.

JetBlue Airways (JBLU) is expected to report on April 28.

Index Summary

• The major market indices finished higher this week.  The Dow Jones Industrial Average (DIA) rose 1.42 percent. The S&P 500 Stock Index also rose 1.75 percent, while the Nasdaq Composite (QQQ) rose 3.25 percent. The Russell 2000 (IWM) small capitalization index rose 1.25 percent this week.
• The Hang Seng Composite gained 1.32 percent this week; while Taiwan rose 3.58 percent and the KOSPI jumped 0.76 percent.
• The 10-year Treasury bond yield (TNX) rose 4 basis points to 1.91 percent.

Domestic Equity Market

The S&P 500 (SPY) ended higher for the week, rising 1.75 percent as markets have been responding positively to earnings that are coming out better than expected and to a lower profit shortfall than analysts forecasted.

Strengths

• Technology stocks led the way as investors cheered the quarterly results of Amazon.com, Inc. (NASDAQ:AMZN), Microsoft Corporation (NASDAQ:MSFT) and Google Inc (NASDAQ:GOOG) (NASDAQ:GOOGL). A common theme was that the companies are growing sales outside of their bread-and-butter businesses.
• The telecommunication services sector was the second best performer, led by AT&T which rose despite missing earnings and revenue estimates.
• Amazon was the top performer in the S&P 500 this week, rising 18.52 percent on the back of a strong first-quarter earnings report.  The retail giant posted a first-quarter loss of 12 cents per share, beating Wall Street’s expectations. Last year, the company lost 23 cents per share. As for the top line, revenue came in at $22.7 billion, slightly ahead of the $22.4 billion analysts had in mind. Sales jumped 15 percent year-over-year. The real bombshell in Amazon’s earnings report was how its cloud business is doing, known as Amazon Web Services. This is the first time the company broke out figures for the cloud business. Net sales stood at almost $1.6 billion, up from about $1 billion during the first quarter of last year. As for guidance, Amazon expects revenues to rise between 7 and 18 percent year-over-year during the second quarter.

Weaknesses

• The energy sector was up marginally, but lagged other sectors for the week as technology took the spotlight amid positive earnings releases.

• S&P 500 companies’ sales in the first quarter were hit even harder than expected by the U.S. dollar. Out of the 201 S&P 500 companies that reported first-quarter earnings as of Friday, 55 percent fell below analysts’ revenue forecasts. Typically, 39 percent of S&P 500 companies miss sales views.

• PulteGroup was the worst performer in the S&P 500 this week, falling 9.3 percent. The company reported first-quarter results that missed views due to fewer closings in what the company’s CEO called “a sustained but slow recovery” in the housing market.

Opportunities

• One upside to the recent disappointing data releases out of the U.S. is that it would allow the Federal Reserve to withhold from raising rates anytime soon, allowing equities to rally further.
• German business confidence rose to a 10-month high in April, largely due to optimism over the European Central Bank’s (ECB’s) bond purchasing program.
• The breakeven inflation rate on U.S. 5-year government bonds reached its highest point since September. The rebound in inflation expectations is certainly a positive sign for the U.S. and global recovery.

Threats

• The U.S. Markit Manufacturing purchasing managers’ index (PMI) came in lower than expected this week. With U.S. economic data continuing to surprise to the downside, equities could be negatively impacted.
• Retail stocks have failed to see any further momentum as oil prices appear to be recovering. If oil continues to rally, retailers may see further pullbacks due to reduced consumer disposable income.
• The dollar remains at its extended level and continues to weigh on companies with a significant amount of foreign revenue exposure.

The Economy and Bond Market

For the week, global stocks were mixed. However, the Nasdaq Composite Index set an all-time high, surpassing the mark set in March 2000. The yield on the US 10-year Treasury note rose above 1.9 percent. Crude oil prices extended their substantial gains of recent weeks.

Strengths

• Sales of previously owned homes rose to the highest level in 18 months this March, a sign that the housing market is gaining strength after a slow start to the year. Existing-home sales increased 6.1 percent from February to March, to a seasonally-adjusted annual rate of 5.19 million, according to the National Association of Realtors. That was the highest level since September 2013. Economists surveyed by The Wall Street Journal expected March sales would increase to a pace of 5.03 million.

• With roughly one-third of S&P 500 companies reporting first-quarter earnings, 71 percent have exceeded lowered expectations so far.

• Gains seen in the Nasdaq were led by blue chip names such as Microsoft which surged more than 10 percent. The company posted earnings and revenue that beat estimates after the close on Thursday, as the firm shook off the negative impact of the strong U.S. dollar with growth in hardware sales and commercial cloud computing.

Weaknesses

• Sales of new U.S.