Airlines with best airfare trade down as fuel prices rise will have ‘relative prosperity’: Analyst

Citi Managing Director of Americas Airlines Steve Trent joins Yahoo Finance Live to discuss the decline of airline stocks and what is trending in the airline industry.

Video transcript

- Well, airline stocks are tumbling today after American Airlines' first quarter profit guidance coming in below the Street's estimates due to higher labor and fuel costs. American down just about 9% right now with less than an hour to go in the trading day. You're looking at many of its competitors, United and Delta, among the names trading to the downside. United off just about 7%.

Steve Trent, Citi managing director of Americas Airlines, here with us today. And Steve, it's great to see you here. So let's talk first about what we just got here, update from American, your reaction to that and what it really signals. Does it signal anything for the rest of the sector?

STEVE TRENT: Appreciate that. Good afternoon. And thank you for having me on.

I think in terms of the American Airlines guide, there was some expectation that we would have seen the unit revenue guidance toward the high end of the range. So when we look at the unit revenue guide this morning coming at a 25.5% year-on-year increase, that's relative to the 24% to 27% range that the carrier had talked about previously. So I think there was some expectation that they would have been toward the top of the range. And coming in the middle of the range, I guess, wasn't good enough for some.

Sort of a strange situation. You have-- the total revenue is going to increase 35-some-odd percent year on year when one considers unit revenue and capacity growth. And you had a little bit of a few points per gallon-- cents per gallon relief on fuel. So actually, EPS guidance increased. So fundamentally speaking, I'm not 100% sure if that justifies a 9% fall. But certainly I think elements of the market were looking for a little more on the unit revenue side.

DAVE BRIGGS: They cited high labor and, to your point, fuel costs. Will all the airlines be impacted equally by those two factors ahead?

STEVE TRENT: Maybe not. So you have the group in different stages, for example, on where they are with pilot contracts. If you look at the big four, for example, Delta Airlines is the only one that looks like it's signed on the dotted line and has something inked in terms of what it's going to pay its pilots.

You know, American Airlines several weeks ago had telegraphed that it's going to-- at least was planning to match Delta's pilot pay. A little unclear, you know, how that's going to work out. On the fuel side as well, you know, if you look at the big four, Southwest Airlines has some fuel hedges, synthetic fuel hedges, in fact, a lot of fuel hedging. Delta Airlines, per se, doesn't do any synthetic fuel hedging, but it does have a natural fuel hedge through its training refinery. And then United and American don't have any hedging, so to speak.

So you will see some difference on that level. One should also arguably see some difference in terms of the extent to which these carriers are exposed to New York Harbor-grade jet fuel kerosene, which has been-- let's say this region has experienced higher crack spreads in intermediate distillate such as fuel relative to other parts of the country. So I would not expect the fuel results per gallon to be uniform.

- Steve, we've talked a lot about this pent-up demand for travel. Consumers are paying whatever it costs to really go on any trip. Are we starting to see consumers trade down and really hunt for those lower fares? And what airlines are most at risk from that shift?

STEVE TRENT: Yeah. No, great question. So I think two places in the group we think are relatively protected from that-- you either have to be a network carrier with really good international long haul over the transatlantic and over the places that are recovering on the transpacific. So you look at those corridors, for example. United and Delta Airlines have the most metal on those corridors relative to the other US carriers.

So I think a year from now, for example, we'll probably be talking about how good some of these international long-haul corridors look. And maybe there's some moderation on the US side. Now, I certainly don't think-- at least the data is not telling us at this juncture that US demand is collapsing. We're having this big meltdown in American Airlines over unit revenue growing almost 26%. It's a little bit hard to believe on that level.

But I think as we get later into the year and into next year, do we get more moderation in the US side? Do we get yields coming off a little bit more, partially because oil's come down a lot over the last year? And if you do get some economic softness, for example, that would be a situation where some consumers would trade down, looking for cheaper seats.

So if we do get that kind of US domestic scenario, the carriers with the best seat knockoff profile look very well positioned. That would be Frontier Airlines, which has much cheaper fares than almost everybody else and probably gets a bigger gain from a seat mile cost perspective, from lower jet fuel. So those are kind of the two places where I think you'll see relative prosperity. And the folks that are in the middle ground may have a slightly tougher time than others.

DAVE BRIGGS: And you have a $61 price target on Delta to buy rating-- significant upside there. Why? What separates them from the pack, and what are your expectations for earnings?

STEVE TRENT: Sure, absolutely. So if one looks at Delta, for example, as I mentioned, you do definitely have very good momentum on these international long-haul corridors, one. Two, when you look at the CapEx spend, I think you have a happy medium. And on one level, you have some airlines that do have a lot of CapEx spending to do. On the other hand, you have other carriers like American that for 2023 has a very good free cash flow outlook because it's going to have very little CapEx this year. And I'm not convinced that's going to last.

Three, on top of that, when we're looking into 2024, the Street's still struggling to reach a consensus on earnings visibility. And if you're at Delta Airlines, as I mentioned, you already have a pilots' agreement in place. You know, in terms of looking at these really good non-ticket revenue sources, Delta has also shown leadership in terms of its generation of cash revenue from loyalty program and the co-branded card segment.

So 2009, Delta did just over a billion dollars of cash revenue from these areas. 2021, they're up to $4.1 billion. They did $5.5 billion last year. There's a plan to get to $7 billion by 2024.

Are we going to see any softness in credit card spend, given everything that's going on on an economic level? Yes, that's possible. But, you know, in Delta's case you have more cushion than you do with some of the others.

You know, in terms of tomorrow morning's print, I think unit revenue, we are actually in our case a little below where American Airlines unit revenue came out this morning. And that's partially because Delta has a harder year ago comp. Maybe our $0.33 target on EPS is-- excuse me, estimate on EPS is above consensus because we do think that these international corridors are going to support revenue. And maybe we got a little break from fuel.

I think what is a little less clear on a short-term basis, what sort of puts and takes we could see from ex-fuel seat mile costs. So my estimate in that regard is maybe somewhat at risk from some of my competitors. But I think more broadly speaking, you know, what's really going to be pertinent as we look forward is what these carriers start telegraphing about the summer travel season. So are we continuing to see that very good countercyclical demand that we have been seeing? Even with American Airlines, we're still seeing--

DAVE BRIGGS: Sure.

STEVE TRENT: --year-on-year revenue growth in the 30s, and the Street hates it. So kind of an odd environment we're in at the moment.

DAVE BRIGGS: Yes. Sir, looks like no pullback in terms of travel demand out there. Steve Trent, good to see you, sir. Thanks so much.