Are Lower Oil Prices Already Hurting Airline Revenue?

By Markets Fool.com

Jet fuel is the biggest cost item for most airlines, so the recent drop in oil prices has created a huge windfall for the industry. When jet fuel prices began to fall in September, airline stocks also underperformed -- for a while. But in the past two months, investors have abandoned their caution, and airline stocks have soared.

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AMEX Airline Index vs. Jet Fuel Price Chart, data by YCharts.

However, a new risk is quickly coming into focus. As oil prices fall, many airlines might be tempted to ramp up growth and cut ticket prices to fill the additional seats. Indeed, airlines across the spectrum -- from business-oriented American Airlines to budget carrier Spirit Airlines -- could already be experiencing some unit revenue pressure.

One day, two disappointments
On Monday morning, American Airlines reported that its November load factor -- the percentage of seats filled with paying customers -- declined from 78.8% to 77.7%. The carrier also projected that its unit revenue will be somewhere between down 1% and up 1% for the fourth quarter.

That is a decrease from the company's previous guidance for unit revenue to be flat to up 2% in the quarter. American Airlines did not provide any further details explaining its lowered expectations. However, it reaffirmed its 10%-12% pre-tax margin guidance for the fourth quarter.

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American Airlines reduced its Q4 unit revenue guidance on Monday. Photo source: American Airlines.

Spirit Airlines was a little more forthcoming. On Monday afternoon, it announced that while peak bookings for the holiday season have been strong, last-minute fares have trended lower since the company provided its fourth-quarter guidance in late October. Spirit also stated that capacity growth related to the Wright Amendment's expiration was causing pricing pressure in Dallas.

As a result, despite the ongoing drop in jet fuel prices and lower-than-expected nonfuel costs, Spirit now expects a fourth-quarter adjusted operating margin of 18%-19%. That is slightly lower than its original guidance for an 18.5%-19.5% adjusted operating margin. Spirit reaffirmed its estimate that its first-quarter 2015 operating margin will be around 20%.

How widespread is the weakness?
It's important to keep the lowered guidance from American Airlines and Spirit Airlines in perspective. Both companies still expect to earn record margins this quarter. Based on the current price of jet fuel, fuel price savings should easily outweigh unit revenue pressure next year, too, permitting further margin expansion.

Spirit plans to grow capacity almost 30% next year. Photo source: Spirit Airlines.

American Airlines and Spirit Airlines also might be feeling more pain than other airlines. Dallas is American Airlines' biggest hub market. If competitive pressure from the opening of Love Field to long-haul flights is impacting Spirit Airlines' unit revenue, it's also probably hurting American.

That said, it's troubling that airlines are already running into unit revenue pressure when fuel prices began to tumble just three months ago. Spirit and several other smaller airlines plan to grow faster next year -- as does Southwest Airlines, one of the biggest domestic carriers. (Southwest plans to increase capacity 6% in 2015: its fastest growth rate since the Great Recession.)

Faster capacity expansion means -- all else being equal -- unit revenue pressure will get worse in 2015. For smaller carriers, the prospect of growing faster and boosting long-term economies of scale might justify passing on a significant proportion of their fuel savings to customers.

For network carriers like American Airlines, this is a more troubling development. In the short run, faster growth by their smaller rivals will gradually erode their fuel-related windfall profits. In the long run, it could undermine the oligopoly market structure that has been the foundation of their recent success.

The article Are Lower Oil Prices Already Hurting Airline Revenue? originally appeared on Fool.com.

Adam Levine-Weinberg has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.