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Airline Sector Expected to Continue Earnings Nosedive

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October 7, 2016
Airline Sector
istock/muratart

Airlines have benefited from strong tailwinds over the past several years. Low oil prices, growing global demand, and industry consolidation helped some of the big carriers achieve record profits over the past year. Industry consolidation has helped minimize the hypercompetitive price wars of the past and allowed airlines to maintain higher fare prices while benefiting from lower expenses. Average ticket prices in 2015 declined slightly, but profits in the airline industry have gotten a big boost from low oil and jet fuel prices. The airline industry’s strong run has been coming to an end this year and earnings are expected to decline 35% over last year in Q3 according to FactSet Research. So far this year, share performance across most of the airline industry this year has significantly underperformed versus the S&P 500.

Revenues have been declining at several of the major carriers in the first half of the year. Delta Airlines’(DAL) second-quarter revenue decreased 2.4% year-over-year, to $10.5 billion, and is projected to decline 4.3% in Q3. DAL is set to report on October 12 and analysts estimate an average EPS of $1.64 on revenue of $10.63 billion. United Continental Holdings’(UAL) also saw its second-quarter revenue decline 5.2% year-over-year, to $9.4 billion, and revenue is projected to decline 4.4% in Q3. UAL is set to report on October 20 and analysts estimate an average EPS of $2.88 on $9.85 billion in revenue. American Airlines (AAL) second-quarter revenue declined 4.3% year-over-year, and is projected to decline 2.5% in Q3.  AAL is set to report on October 21 and analysts estimate an average EPS of $1.57 on revenues of $10.44 billion.

Smaller carriers, like Southwest Airlines (LUV), JetBlue Airways (JBLU), and Alaska Air Group (ALK) have been able to continue to grow revenue and profits through route expansions and adding frequencies and connections in additional markets. Southwest’s second-quarter revenue increased 5.3%, and the company posted a record profit of $820 million, up 34.9% over last year. Analysts expect an average EPS of $0.88 on $5.15 billion in revenue when the company reports on October 26. JBLU’s revenue growth has been slowing, but still increased 1.9% in Q2. Analysts expect an average EPS of $0.59 on $1.72 billion in revenue when the company reports on October 25.

ALK expects to complete its $2.6 billion acquisition of Virgin America in the fourth quarter, but is still deciding how to integrate the new brand into its business. The company’s revenue growth has also slowed, but it continues to grow in the low single-digits. ALK is set to report on October 20 and analysts estimate an average EPS of $2.07 on $1.72 billion in revenue.

Bigger Buybacks and Dividends

Airlines have been using their excess cash to aggressively repurchase shares and increase dividends. Delta Airlines (DAL) increased its dividend by 50% and planned to buyback $3 billion in shares in the second quarter. As American Airlines (AAL) share price has tumbled, management has spent billions of dollars buying back shares. United Continental Holdings (UAL) also announced plans to repurchase $2 billion worth of shares, roughly 13% of the company’s market value. All else equal, the size of these buybacks has helped boost earnings per share in recent quarters.

Trouble if Oil Prices Head Higher

The industry could face challenges if oil prices rise faster than expected, which is a possibility after OPEC’s recent agreement to curb production to support oil prices. The impact on different airlines could vary depending on how they’ve hedged fuel prices. Many carriers have chosen to minimize fuel hedging or abandon it all together due to low oil prices and losses on the strategy in the past. Last year, Delta Airlines had a financial adjustment of $2.3 billion and United Continental Holdings had financial adjustments of $960 million as a result of the company’s fuel hedging. American Airlines has benefited more than other carriers after it decided to stop hedging altogether in 2014. A riskier long-term strategy, but one that seems to have paid off in the short term.

Too Much Capacity?

One of the challenges airlines face is trying to match capacity growth with demand growth. Airlines want to fill as many seats as possible on each flight to maximize profit, but they also want to make sure they can meet growing demand. Many companies have been spurred by low fuel prices and interest rates to invest in fleet renewals and purchase new aircraft. Industry consolidation has helped minimize the supply of flights and keep fares higher. If airlines expand capacity too much and travel demand falls in the future it could put downward pressure on profits among major carriers if they lower fares to try to fill seats.

Will declining airfare prices have an impact on the airline industry's earnings?
According to Federal Reserve CPI data, airline fares are at their lowest point since 2010. Figure 1 below shows Consumer Price Index (CPI) data for average airline fares, dating back to 1989. You can find this report, and nearly 400,000 other Federal Reserve data points inside the thinkorswim platform with the new Economic Data tool.

Airline Airfare prices 1989-2016

FIGURE 1: AIRFARE TURBULENCE.

Consumer Price Index data for average airline fares, 1989-2016 show fares are at their lowest since 2010. Data source: Federal Reserve CPI data. Chart source: thinkorswim. For illustrative purposes only. Past performance does not guarantee future results.

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