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Airlines Finally Find A Happy Medium
Back when oil was priced at more than $140 per barrel, Wall Street was worried (and it was a legitimate worry) that airlines would be forced to price themselves out of business. But, when crude oil prices fell to multi-year lows just above $30 per barrel in January and February, the worries shifted from oil being too expensive to passenger demand being too weak, which could also lead to bankruptcy. (Take a look at our Airline Industry Handbook for a quick primer on the industry.)
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Are Airlines Doing Poorly?
But wait a second - if the supply of airline tickets gets cheaper per ticket as oil prices tumble, then the demand for air travel should actually increase, right?
The textbook answer is "yes"; the real-world answer is "it depends." In the current scenario, you don't have to be a genius to recognize that the recession lessened the need for air travel at almost any price.
A funny thing has happened since then - the S&P 1500 Airline Stock Index has gained nearly 60% since March's low, topping the S&P 1500 Index gain of about 43%. If things are so bad, why are these stocks doing so well? Here's a theory - perhaps things aren't actually so bad. If so, then airlines present an opportunity.
Turning the Corner
Don't take the broad airline bad-mouthing at face value. JetBlue (NASDAQ: JBLU) and US Airways (NYSE: LCC) posted a swing back to profits during the second quarter of the year. AirTran (NYSE: AAI) posted earnings per share of 34 cents after a one-time charge, topping estimates of 32 cents. Even Delta's (NYSE: DAL) loss of 24 cents per share (excluding merger expenses) was better than the expected 29 cent loss.
Granted, revenue is still down, and it was fortunate fuel hedging that led to US Airways gain, but between US Airways, JetBlue and AirTran, there's a reasonable hope for positive earnings going forward.
Simultaneously, oil prices have stabilized in the $50 to $70 range, at least for the time being. Not too hot, not too cold, which should make it easier for airlines to hedge their fuel costs. In fact, had it not been for fuel hedge losses, Delta would have also turned an operating profit last quarter.
As for ticket pricing, that seems to be reflective of stable oil prices as well. During the first quarter of the year, domestic air fares fell 9.1% below the average fares during Q4 of last year, and were more than 12.5% below 2008's peak prices. In other words, flying is getting more affordable and demand should improve as a result.
On that note, demand is already showing some healing. On a year-over-year basis, US Airways said the declines in July's corporate travel were lessening when compared to May and June, and revenue per available seat mile was getting sequentially stronger. It's still a "less bad" proposition, but an improvement all the same. On the other hand, not all airlines were singing the same tune, and none are jumping for joy about passenger counts.
In the Sweet Spot
Could it be that the airlines have finally found the happy medium between oil prices and passenger demand? While many airlines' management and spokespeople - along with industry analysts - are still saying to expect challenges, the market's strong buying of these stocks clearly says investors don't agree with the pessimism.
In this instance, I'm more inclined to side with the market than with the analysts or corporate figureheads. After all, most of them underestimated the effect of the recession, and perhaps they're also underestimating the effects of an economic rebound.
Bottom Line
It's still certain to be a bumpy flight, and not all airlines will reach their destination profitably. However, I made two broad observations that may well be separating the winners form the losers in this group. First, traffic (filling seats to capacity) actually matters now. Historically, metrics like revenue per seat and total passenger count haven't necessarily had a clear impact on the bottom line. They do now though. Second, fuel cost hedging can be a profit game changer. It cost Delta an operating profit in Q2, but actually led US Airways to a profit in the same quarter. Airlines have to get it right.
I see more upside than downside for most of the major air carriers at this point. (For additional reading, check out Is That Airline Ready For Lift-Off?)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
Are Airlines Doing Poorly?
But wait a second - if the supply of airline tickets gets cheaper per ticket as oil prices tumble, then the demand for air travel should actually increase, right?
The textbook answer is "yes"; the real-world answer is "it depends." In the current scenario, you don't have to be a genius to recognize that the recession lessened the need for air travel at almost any price.
A funny thing has happened since then - the S&P 1500 Airline Stock Index has gained nearly 60% since March's low, topping the S&P 1500 Index gain of about 43%. If things are so bad, why are these stocks doing so well? Here's a theory - perhaps things aren't actually so bad. If so, then airlines present an opportunity.
Turning the Corner
Don't take the broad airline bad-mouthing at face value. JetBlue (NASDAQ: JBLU) and US Airways (NYSE: LCC) posted a swing back to profits during the second quarter of the year. AirTran (NYSE: AAI) posted earnings per share of 34 cents after a one-time charge, topping estimates of 32 cents. Even Delta's (NYSE: DAL) loss of 24 cents per share (excluding merger expenses) was better than the expected 29 cent loss.
Granted, revenue is still down, and it was fortunate fuel hedging that led to US Airways gain, but between US Airways, JetBlue and AirTran, there's a reasonable hope for positive earnings going forward.
Simultaneously, oil prices have stabilized in the $50 to $70 range, at least for the time being. Not too hot, not too cold, which should make it easier for airlines to hedge their fuel costs. In fact, had it not been for fuel hedge losses, Delta would have also turned an operating profit last quarter.
On that note, demand is already showing some healing. On a year-over-year basis, US Airways said the declines in July's corporate travel were lessening when compared to May and June, and revenue per available seat mile was getting sequentially stronger. It's still a "less bad" proposition, but an improvement all the same. On the other hand, not all airlines were singing the same tune, and none are jumping for joy about passenger counts.
In the Sweet Spot
Could it be that the airlines have finally found the happy medium between oil prices and passenger demand? While many airlines' management and spokespeople - along with industry analysts - are still saying to expect challenges, the market's strong buying of these stocks clearly says investors don't agree with the pessimism.
In this instance, I'm more inclined to side with the market than with the analysts or corporate figureheads. After all, most of them underestimated the effect of the recession, and perhaps they're also underestimating the effects of an economic rebound.
Bottom Line
It's still certain to be a bumpy flight, and not all airlines will reach their destination profitably. However, I made two broad observations that may well be separating the winners form the losers in this group. First, traffic (filling seats to capacity) actually matters now. Historically, metrics like revenue per seat and total passenger count haven't necessarily had a clear impact on the bottom line. They do now though. Second, fuel cost hedging can be a profit game changer. It cost Delta an operating profit in Q2, but actually led US Airways to a profit in the same quarter. Airlines have to get it right.
I see more upside than downside for most of the major air carriers at this point. (For additional reading, check out Is That Airline Ready For Lift-Off?)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
by
James Brumley
James Brumley is a freelance writer and registered investment advisor. He began his career as a broker with a major Wall Street firm, where fundamentals and long-term holding periods were core strategies. After that, he switched gears completely, becoming an analyst at a short-term trading newsletter that focused on technical analysis. He now manages client money using the best of both philosophies. His company, Bluegrass Portfolio Management, offers investors an opportunity to reap superior returns with minimized risk.
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