3 Reasons Airline Stocks Are Expensive at Any Price

by Susan J. Aluise | November 4, 2011 7:40 am

On the surface, airline performance seems to be taking off — operational performance measurements like load factors are on the rise, and flights are likely to be packed for the holidays. Even JPMorgan analysts were optimistic about the sector on Thursday, noting that airlines have a good shot at being “profitable in a recession” — even though that’s never happened in the industry’s history.

But you only need to peek at the most recent earnings reports to know that it’s still a tough time to make money in this business. United Continental (NYSE:UAL[1]), AMR Corp.’s (NYSE:AMR[2]) American Airlines, Delta (NYSE:DAL[3]) and SkyWest (NASDAQ:SKYW[4]) all missed analysts’ estimates.

Southwest (NYSE:LUV[5]) and US Airways (NYSE:LCC[6]) fared better, but both airlines took big hits on fuel-related costs.  JetBlue (NASDAQ:JBLU[7]) earnings slipped 23% over the same quarter last year, while Alaska Air’s (NYSE:ALK[8]) profit fell 37%.

And the positive news of full holiday flights ignores the fact that passenger volume is expected to fall by 2%.  Airlines are rolling with that challenge by substituting smaller, more fuel-efficient aircraft on many routes.

Still, a global slowdown in passenger markets has disproportionately affected North American carriers, which reported a mere 2.9% growth in August.  That’s the weakest performance in any region — and a huge drop from the 5.6% growth rate earlier this year. Fare and fee hikes by airlines are unlikely to offset the lost income.

Although airline stocks look pretty cheap right now (having fallen an average of 41% this year), here are three reasons to avoid them at any price right now:

  1. Fuel Price Volatility. The lack of stability has eaten airlines’ lunch this year. High prices earlier this year forced airlines to cut capacity and use hedging to mitigate prices over $100 a barrel.  But when prices fell, fuel hedge losses cost airlines billions. That’s because fuel now accounts for 40% of airline costs.  Consider Southwest, which reported a third-quarter loss of $240 million — its first losing quarter in two years. Without its fuel hedge losses, LUV would have earned $122 million in the quarter. Even with hedging, Southwest’s $1.6 billion fuel bill was more than 70% higher than last year.
  2. Threat Of New Federal Taxes. The White House is proposing – and the Congressional super-committee is now considering — two new airline taxes. The first would add a new $100 departure tax – disguised as a fee — to all flights, and the second would double the existing passenger security tax to $5 for each one-way trip in 2012, and triple the tax to $7.50 by 2017. The Air Transport Association, the airlines’ national trade group, estimates that the new departure tax alone would cost U.S. airlines up to $1 billion a year and eliminate 10,000 jobs.
  3. European Emissions Trading Scheme.  The European Union plans to force any airline using an EU airport to pay taxes under its greenhouse emissions-trading scheme. U.S. airlines could be forced to pay more than $3.1 billion in EU taxes between 2012 and 2020, according to the ATA.

Is the airline industry down forever?  No, but there is still a lot of risk that’s not priced in for the sector.  And individual airlines have their own headwinds, too.  The bankruptcy watch for AMR may continue if a merger partner doesn’t show up. Southwest’s merger with AirTran will inject costly complexity and impact performance in the short term. Fuel price volatility will continue to hit all airlines and a still-sluggish economy likely will impact margins at least through the second quarter of 2012.

Endnotes:
  1. UAL: http://studio-5.financialcontent.com/investplace/quote?Symbol=UAL
  2. AMR: http://studio-5.financialcontent.com/investplace/quote?Symbol=AMR
  3. DAL: http://studio-5.financialcontent.com/investplace/quote?Symbol=DAL
  4. SKYW: http://studio-5.financialcontent.com/investplace/quote?Symbol=SKYW
  5. LUV: http://studio-5.financialcontent.com/investplace/quote?Symbol=LUV
  6. LCC: http://studio-5.financialcontent.com/investplace/quote?Symbol=LCC
  7. JBLU: http://studio-5.financialcontent.com/investplace/quote?Symbol=JBLU
  8. ALK: http://studio-5.financialcontent.com/investplace/quote?Symbol=ALK

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