In this week’s 64 page PlaneBusiness Banter, we take a closer look at the earnings results and the earnings calls for six major airlines — United Airlines, JetBlue, US Airways, Alaska Air Group, Southwest Airlines, and Allegiant.
There is one issue that I think needs to be discussed as widely as possible, and that is the issue of how airlines account for out-of-period hedge gains or losses.
Without getting into too much accounting mumbo jumbo, if an airline engages in hedging activities, in an attempt to mitigate the high cost of fuel — that is going to, hopefully, create a situation where those hedging instruments essentially make money, thereby lowering the effective price the airline pays for fuel.
The issue is — how does an airline then account for these gains?
In the case of Southwest, Alaska Air Group, and US Airways, for instance, the airlines have, I believe, chosen to break out these gains in the proper fashion.
But other airlines, such as United Airlines, do not do this.
So why should you care? Because it can make a huge difference in what an airline’s true net income is. Or perceived to be.
In the US Airways‘ earnings call this quarter, analyst Mike Linenberg with Merrill Lynch asked management at US Airways, why they chose to report the unrealized gains or gains that relate to future periods the way in which they do – as a special item.
Mike, inaccurately, I would add, claimed that ‘the rest of the industry’ is running the numbers through their P&Ls.’ (Note, not everyone is doing this, as I note above.)
As Mike then correctly observed, “It seems like perception is what trumps reality with respect to stock price and call it overall financial strength. Is– is that something that you would reconsider just so you’re on the same page as everybody else?”
US Airways’ CEO Doug Parker responded that the airline thinks it is the proper accounting method to use.
We agree.
In the Southwest Airlines’ call, CFO Laura Wright also clearly explained why they do what they do in accounting for the gains — and again, it makes sense.
To give you an idea of how much difference this accounting difference makes — let’s just take the example of US Airways and United Airlines for the second quarter.
Using what we believe to be the correct method of accounting, US Airways reported a loss of $101 million. Had they run the hedging related gains through their P&L, the airline would have reported a profit of $89 million.
On the other side of the coin, United Airlines reported a loss of $151 million for the quarter. However, if they had reported their hedging activity in what we think is the proper way, the airline would have reported a loss of $380 million or $2.99 a a share, a fact that analyst Dan McKenzie with Credit Suisse emphasized in his research report on the airline’s earnings.
It’s a big difference.
And one that all airline investors, employees, and interested bystanders need to remember when they look at the numbers being reported this quarter by a particular airline.