Lower oil prices gave most U.S. airline stocks a bounce last week — not a surprising development since fuel accounts for as much as 40% of an airline’s operating costs. JPMorgan (NYSE:JPM) analyst Jamie Baker last week estimated that the savings from lower fuel would create $5.5 billion in annual “windfall” profits for the airlines.
While lower fuel prices are good news, airlines have lots of other problems, so be choosy when playing the sector.
Here are four reasons to doubt the sector’s latest attempt to ascend:
Fuel Price Volatility
It’s not just high jet fuel prices that are eating airlines’ collective lunch — it’s wild swings in fuel prices. Carriers make very precise measures of supply and demand, and determine how to get the most bang for their fuel buck.
In the commercial aviation industry, that’s known as capacity planning. When fuel prices are high, airlines are more likely to reduce capacity by filling all the seats in smaller, more fuel-efficient aircraft. When fuel prices are low, they can increase capacity by flying larger aircraft.
Although most airlines try to mitigate high fuel prices with tactics like hedging (or in Delta Air Lines’ (NYSE:DAL) case, buying an oil refinery), they can also lose big when fuel prices fall unexpectedly.
The Mess in Europe
The situation in Greece will keep casting a pall over Europe in the near future — and the continent already had been headed toward recession. That’s bad news for U.S. airlines that fly there, like Delta, United Continental (NYSE:UAL), American Airlines (PINK:AAMRQ) and US Airways (NYSE:LCC).
U.S. airlines will need to decrease capacity to Europe as the year wears on. Airlines for America (A4A), the trade group that represents U.S. carriers, says airlines will cut capacity to Europe by nearly 8% in the fourth quarter of this year. That could be tough on earnings because Europe remains U.S. airlines’ largest international market. Delta already has announced plans to cut its trans-Atlantic capacity by 5% after Labor Day.
Higher TSA Taxes
Airlines aren’t getting a lot of help from Congress. A key Senate committee last week advanced a bill that would double transportation security taxes from the current $2.50 for a one-way flight segment to $5. That affects every airline including Southwest-AirTran (NYSE:LUV), JetBlue (NASDAQ:JBLU), Alaska Airlines (NYSE:ALK), Spirit (NASDAQ:SAVE) and SkyWest (NASDAQ:SKYW).
Although carriers will pass the tax hikes on to their passengers, revenue is still likely to take a hit. “It’s a simple equation: When you add taxes, demand for air travel is dampened, resulting in lost jobs and lost air service,” said A4A President and CEO Nicholas E. Calio. “Our customers today pay 20% – $60 on an average $300 domestic roundtrip ticket – of their ticket prices in taxes, on par with taxes for alcohol and tobacco, products taxed to discourage their use.”
Consolidation has been proven time and again to be a good thing for airlines: It delivers broader reach, economies of scale and financial benefits. But marriage is easy compared to the daily challenges of living together after the honeymoon.
Delta’s combination with Northwest in the middle of the Great Recession was acclaimed as a success story, in large part because Richard Anderson, DAL’s chief, had spent more than three years running Northwest in the early 2000s. Even so, the merged carrier still struggled with its labor unions. United Continental is fightng through major computer integration glitches now, and its customer approval has plummeted.
Early into the process of integrating operations with AirTran, Southwest has made some progress — notably subleasing AirTran’s Boeing (NYSE:BA) 717s to Delta so that the combined carrier could standardize on the Boeing 737. AirTran, which already flies to Mexico, last week launched new international flights to that country and to Puerto Rico.
But Southwest’s flight attendants last week voted down a deal that would have allowed the carrier to fly internationally or over water. Thorny issues like these pose significant challenges for combined carriers it the near term.
Still, one airline has a good chance to buck these industry headwinds.