Alaska Air (ALK), Southwest (LUV) and American Airlines (AAL) beat earnings expectations last week, boosted in part by declining fuel costs. In recent quarters, U.S. airliners have reported strong financial performance, fueled in part by consolidation in the industry and less competition and cheaper energy costs. Airline stocks were hit hard in the wake of 9/11 and the global financial crisis, but what has emerged may be a leaner, more competitive fleet of companies prepared to weather economic cycles in a way this industry never has been before.
The plunge in recent years from crude oil above $100 per barrel to below $40 per barrel helped boost profits at U.S. airliners. "They have been a big beneficiary of the low price of crude," says JJ Kinahan, Chief Market Strategist at TD Ameritrade. Beyond the good fortune of low energy costs, airlines have become more efficient, Kinahan says. "As anyone who has flown recently can attest to, over the last few years they have maximized the amount of people on a flight. We are also seeing some consolidation in the industry, like the American and Alaska deal."
It's Not Just An Oil Story
This all adds up to significant improvement in the fundamentals for airlines, says Jim Corridore, director industrials research at S&P Global Market Intelligence. "Prior to 2008 there were too many seats chasing too few people. Through consolidation and bankruptcy the industry has right-sized itself. Since 2008, airlines are showing improved fundamentals even before oil prices started to decline," Corridore says.
Nonetheless as recent airlines earnings news revealed, crude oil in the $40 per barrel range has resulted in an "extra short-term windfall" for airliners, Corridore says.
While the oil impact is most likely a temporary phenomenon, it is important to note where airline companies have funneled their extra profits in recent years. "They've restructured their balance sheets. They are paying down debt. They are buying back shares. They are paying dividends, which is a first for the industry. While the dividends are a pittance, it shows they expect to be profitable for the foreseeable future," Corridore says.
A New Class Of Investor
In the past airline stocks may have been a favorite of the active trader crowd. "Now the stocks are attracting a different class of investor than they ever have before. Now they are being looked at as stocks you can invest in as opposed to just trading," Corridore says. He points to debt-to-cap ratios. Example: Delta in 2008 had $15 billion in debt and they expect to end 2016 with net debt of about $6 billion. "It's apparent the company is much less leveraged," he says.
Clear Skies Ahead?
Corridore outlines a number of positive factors for the airlines industry ahead including:
- Relatively healthy demand as passengers want to travel
- Right-size capacity
- Low energy prices
- Lean cost structures
"We expect the U.S. airline industry to have record profits in 2016 after a record year in 2015. We think airline executives have changed the way they look at the business. Now they are trying to manage their businesses for sustained profitability and a return on invested capital," Corridore says.
Clouds On The Horizon
Economic growth levels could play a factor in demand for travel. "This is an area when people's confidence in the economy grows, airlines may be a direct beneficiary and people may fly more," Kinahan says. The opposite could also be true, of course.
Corridore believes the new wave of executives at the airlines today will react to slower demand by "cutting capacity and offering fewer seats, instead of cutting air fares. It’s not that great if you are a traveler, but is good if you are an airline stock investor."
Stock Selection Could Be Key
With crude oil prices potentially on the rise, stock selection could be key and investors always need to do their homework. The three largest U.S. airlines are American, United (UAL) and Delta (DAL).
"You have to be very name specific. Some airlines are more efficient than others," Kinahan said. Also, "the price of crude is very important overall and there is upside room for crude to get to the $50 level," he says.
Currently, some airlines have crude oil hedging losses, with the price of oil relatively low. While American, for example, "doesn't hedge against oil," Corridore says. That means "American is fully benefiting more than anybody else from the current low prices. But, if oil hits $60 they will be hit the hardest because they don’t hedge."