Shares of Delta Air Lines (NYSE: DAL) slumped 5% on Tuesday, after the airline projected that revenue per available seat mile (RPASM) will be in the lower part of its initial forecast range for the fourth quarter. The guidance update stoked investor fears that a recent pullback in oil prices could spark price wars in the U.S. airline industry, undermining unit revenue.
However, lower fuel prices represent a huge cost tailwind for airlines like Delta. If the recent decline in oil prices sticks, the carrier will be able to afford slower RPASM growth. Moreover, there's no sign that Delta's unit revenue is about to start declining again.
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Delta tweaks its guidance
On Tuesday, Delta Air Lines reported solid traffic for the month of November and updated its fourth-quarter forecast. The company now expects RPASM to rise 3.5% this quarter, which would be near the lower end of its guidance range of 3% to 5% growth.
Nevertheless, due to the sharp pullback in fuel prices since early October, earnings per share should come in near the top of Delta's $1.10-to-$1.30 guidance range. This also means that Delta Air Lines will return to pre-tax margin expansion in the fourth quarter.
RPASM growth remains solid
The negative reaction to Delta's guidance update wasn't especially surprising, given that Alaska Air (NYSE: ALK) and Spirit Airlines (NYSE: SAVE) both raised their Q4 unit revenue forecasts last week. Alaska now expects RPASM to rise 3% to 5% this quarter, well ahead of its initial outlook for a 1.5%-to-3.5% RPASM gain. Meanwhile, Spirit increased its RPASM growth estimate for the quarter from 6% all the way to 11%.
Investors were presumably hoping that other airlines (including Delta) would also post unit revenue growth at or above the high end of their original forecasts for the fourth quarter.
That said, a 3.5% RPASM increase is nothing to sneeze at. It's only slightly slower than the 4.6% RPASM increase Delta averaged for the first three quarters of 2018. Furthermore, Delta is facing a relatively tough comparison this quarter, as the carrier posted 4.4% RPASM growth in the fourth quarter of 2017 compared with 1.7% growth for the first nine months of that year.
Don't underestimate the power of low oil prices
It's also important to recognize that with lower oil prices, Delta doesn't need to keep delivering big unit revenue gains to achieve strong earnings growth. Indeed, jet fuel prices have fallen by about $0.50 per gallon since the airline released its initial Q4 forecast on Oct. 11.
Obviously, it's quite possible that jet fuel prices could bounce back soon. But Delta and other airlines have shown over the past couple of years that they can drive fares and ancillary revenue higher when they need to recoup increases in their fuel costs.
On the other hand, if market jet fuel prices remain near recent levels, Delta Air Lines would likely pay an average of less than $2 per gallon in 2019. For comparison, it paid an average of $2.14 per gallon in the first three quarters of 2018, and its average jet fuel price for the fourth quarter is set to be significantly higher.
Considering that Delta consumes more than 4 billion gallons of jet fuel annually, it could be in line for $1 billion or more of fuel cost savings next year, relative to 2018. That would more than offset its low expected nonfuel unit cost growth for 2019.
The 2019 outlook looks good
If fuel prices hold near current levels, Delta Air Lines could expand its pre-tax margin by more than 1 percentage point next year -- even with no unit revenue growth. And there's no reason to expect RPASM growth to fall all the way to zero in 2019.
Both Spirit Airlines and Alaska Airlines plan to slow their capacity growth dramatically in 2019. JetBlue Airways and Southwest Airlines are also planning for moderate growth relative to historical levels. With all of these airline industry price leaders pulling back on capacity, the chance of a severe fare war breaking out next year is fairly low.
As multiyear comparisons become more difficult, Delta may have to settle for somewhat slower unit revenue growth going forward. But if fuel costs are down even a little bit -- compared with the big year-over-year increases airlines have faced in 2017 and 2018 -- the company is likely to deliver strong double-digit EPS growth. With Delta Air Lines stock trading for just 10 times its projected 2018 EPS, investors should view the recent pullback as a nice buying opportunity.
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Adam Levine-Weinberg owns shares of Alaska Air Group, Delta Air Lines, JetBlue Airways, Southwest Airlines, and Spirit Airlines and is long January 2019 $10 calls on JetBlue Airways. The Motley Fool owns shares of and recommends Southwest Airlines. The Motley Fool owns shares of Delta Air Lines and Spirit Airlines. The Motley Fool recommends Alaska Air Group and JetBlue Airways. The Motley Fool has a disclosure policy.