Good News for American Airlines Investors in Delta's Earnings Report

By Markets

On Thursday, Delta Air Lines (NYSE: DAL) reported somewhat disappointing results for the summer peak season. The company earned a strong pre-tax margin of more than 18%, but a 6.8% decline in passenger revenue per available seat mile (PRASM) caused a year-over-year earnings decline.

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PRASM slumped 6.8% year over year at Delta Air Lines last quarter. Image source: The Motley Fool.

On the positive side, Delta projected that its unit revenue decline would moderate to 3%-5% in Q4. This improving unit revenue trajectory at Delta bodes well for American Airlines' (NASDAQ: AAL) efforts to return to unit revenue growth this quarter.

American Airlines is already outperforming

Whereas Delta just posted its biggest unit revenue decline since the Great Recession, American Airlines' unit revenue trajectory is already much improved. Earlier this week, American raised its Q3 unit revenue guidance. It now expects revenue per available seat mile (RASM) to fall 2%-3% year over year. By contrast, in July, it had expected a 3.5%-5.5% RASM drop.

This marks a big improvement from the 6.1% RASM decline that American Airlines recorded in Q2. About 1 percentage point of improvement stems from the company's updated credit card agreement, but the rest represents a genuine change in revenue trends.

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Let's take a look at three major reasons why American Airlines is experiencing a faster unit revenue recovery than Delta Air Lines -- and why that could continue in Q4.

Favorable geography

First, American Airlines has a larger footprint in regions with better unit revenue trends. In Q2, roughly 74% of its passenger revenue came from the domestic market, compared to 69% for Delta. Slowing industry capacity growth and rising fuel prices are driving a domestic unit revenue recovery. Delta believes that its domestic PRASM could reach the flat line by December. American Airlines will benefit even more as domestic unit revenue trends strengthen.

American Airlines is also well positioned in the international market. Latin America was the only geographic region where Delta returned to unit revenue growth last quarter. This was mainly driven by a sharp turnaround in Brazil, where PRASM surged 30% year over year.

American Airlines is several times Delta's size in Brazil. That means huge unit revenue gains there would have a significant impact on its overall results. PRASM slumped 25% year over year on American's routes to Brazil in Q3 2015, offering lots of room for improvement. However, PRASM fell a stunning 40% on American's Brazilian routes in Q4 2015, so the upside will be even bigger for the current quarter.

American Airlines is poised to deliver strong unit revenue growth in Brazil. Image source: American Airlines.

While American Airlines has a bigger presence in the domestic and Latin American markets than Delta, it is significantly smaller in the transatlantic and transpacific markets. That's helping American right now, as industry unit revenue trends have been much worse in those two regions.

The Dallas competitive environment is easing

Second, American Airlines is finally getting a respite from rapid competitive capacity growth in the Dallas-Fort Worth region, home to its largest hub. It has faced severe unit revenue pressure there over the past two years due to a large capacity buildup by Southwest Airlines at Dallas Love Field.

The last wave of Southwest's expansion in Dallas occurred in mid-August of 2015. Thus, American Airlines finally lapped the impact of this competitive headwind in the middle of last quarter. In Q4, it will finally get a "clean" year-over-year comparison.

Additionally, fare pressure in Dallas has finally convinced Spirit Airlines to make some cutbacks there. Next month, the ultra-low-cost carrier will terminate its routes from Dallas/Fort Worth International Airport to New Orleans, Oakland, and San Diego. That should allow American to pull back on discounting in those markets.

More capacity discipline

Third, American Airlines appears to be even more committed to capacity discipline than Delta Air Lines right now. While Delta expects to limit its capacity growth to just 1% in Q4, American Airlines doesn't plan to grow at all this quarter.

By holding overall capacity flat, American Airlines will have more flexibility than Delta to reduce service in underperforming markets. That should lead to better unit revenue results.

Delta Air Lines expects to report significant sequential unit revenue improvement in Q4. American Airlines should be able to achieve at least the same level of sequential improvement, due to its high exposure to stronger markets, improving competitive capacity trends at its biggest hub, and its plan to hold capacity flat. As a result, American Airlines could become the first legacy carrier to return to unit revenue growth in Q4.

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Adam Levine-Weinberg owns shares of Spirit Airlines and is long December 2016 $30 calls on Spirit Airlines. Adam Levine-Weinberg is long January 2017 $30 calls on American Airlines Group and long January 2017 $40 calls on Delta Air Lines. The Motley Fool recommends Spirit Airlines. 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.