3 Headwinds Pushing Against Soaring Airlines

by Susan J. Aluise | May 23, 2013 9:10 am

If you’ve been holding a position in a U.S. airline stocks since the beginning of this year, go ahead and pat yourself on the back. The sector has gone crazy wild.

But if you missed that flight into the upper reaches of the stratosphere, is now the time to get on board? Well, unfortunately, that answer depends on three factors beyond carriers’ control.

First, though, the good news: Like I said, Delta Air Lines (DAL[1]), United Continental (UAL[2]), US Airways (NYSE:LCC[3]) and Southwest Airlines (LUV[4]) shares have gained an average of 41% since Jan 1. AMR’s (AAMRQ[5]) American Airlines, which is poised to be acquired by US Air, is up a whopping 600% this year … and even “laggard” JetBlue (JBLU[6]) has gained 10%.

Unsurprisingly, the sector has seen some profit taking so far this week, with most airlines down by about 4%.

Nevertheless, airline stocks have been buoyed this year for a couple of key reasons. Lower prices for carriers’ biggest operating cost — fuel — have been a boon to carriers’ bottom lines. Airlines also took in more than $6 billion in baggage and reservation change fees in 2012.

In its annual airline forecast last week, the industry trade group Airlines for America forecast U.S. airlines will carry nearly 209 million passengers globally from June through August — the highest level since the summer of 2008. Plus, that includes 27.4 million international passengers — a record for U.S. carriers.

That’s why first-quarter earnings of the 10 publicly traded U.S. passenger airlines — a group that includes the carriers above plus Alaska Air Group (ALK[7]), Hawaiian (HA[8]), Allegiant Travel Co. (ALGT[9]) and Spirit Airlines (SAVE[10]) — improved markedly from the prior year. The carriers pared back their combined loss to $552 million from $1.7 billion in the same quarter in 2012.

Those positive trends are combined with PEG ratios of as low as 0.10 and cheap valuations: DAL, LCC, UAL and JBLU are trading at forward P/E ratios of between 6 and 9. Heck, LUV is the sector high at just over 11.

So all in all, airline stocks look very attractive right now. But once again, the sector’s continued upward momentum will depend on three factors that largely are out of the carriers’ control. Let’s take a look:

Fuel Price Volatility

Airline shares have surged as oil prices have slumped — a logical move since the cost of fuel accounts for as much as 40% of airline operating costs. Still, for the first quarter of this year, jet fuel prices averaged a hefty $2.98 a gallon, according to the U.S. Bureau of Transportation Statistics[11].

High fuel prices can eat an airline’s lunch, but that’s not the only risk to profitability. Carriers have done a bang-up job of capacity planning — industry code for fuller flights. If fuel prices move markedly in either direction, that balance is much harder to achieve.

Sluggish Global Economy

Airline stocks are cyclical and as such, their fortunes are tied inextricably to the economy. Last month, the International Monetary Fund revised its global growth forecast[12] downward to 3.3% this year, while the U.S. economy is forecast to grow at an anemic 1.9%. That’s hardly a bullish sign for the sector.

Airlines also have been lobbying lawmakers to give the industry a boost by reducing taxes and easing costly regulations, but major progress is unlikely in the near term.

Post-Merger Integration Challenges

It’s no secret that UAL struggled mightily to cope with major computer glitches[13] last year as it worked to combine the separate United and Continental systems from its 2010 mega-merger. While airline consolidation generates powerful operational benefits, the devil is in the details when it comes to combining aircraft fleets, schedules, reservation systems, personnel and the like.

Southwest, which acquired AirTran in 2011, implemented shared itineraries in March but there is still a lot of work to do in the integration process. US Air’s merger with American, which is expected to close in the third quarter, will be a massive undertaking on all fronts. Expect LCC and LUV to experience some degree of consolidation fallout at least through the end of 2014.

As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.

Endnotes:
  1. DAL: http://studio-5.financialcontent.com/investplace/quote?Symbol=DAL
  2. UAL: http://studio-5.financialcontent.com/investplace/quote?Symbol=UAL
  3. LCC: http://studio-5.financialcontent.com/investplace/quote?Symbol=LCC
  4. LUV: http://studio-5.financialcontent.com/investplace/quote?Symbol=LUV
  5. AAMRQ: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAMRQ
  6. JBLU: http://studio-5.financialcontent.com/investplace/quote?Symbol=JBLU
  7. ALK: http://studio-5.financialcontent.com/investplace/quote?Symbol=ALK
  8. HA: http://studio-5.financialcontent.com/investplace/quote?Symbol=HA
  9. ALGT: http://studio-5.financialcontent.com/investplace/quote?Symbol=ALGT
  10. SAVE: http://studio-5.financialcontent.com/investplace/quote?Symbol=SAVE
  11. according to the U.S. Bureau of Transportation Statistics: http://www.transtats.bts.gov/fuel.asp
  12. revised its global growth forecast: http://www.ft.com/intl/cms/s/0/03c36652-a66e-11e2-885b-00144feabdc0.html#axzz2TwzNe8sY
  13. struggled mightily to cope with major computer glitches: http://investorplace.com/2012/11/united-continental-struggles-to-ride-out-post-merger-turbulence/

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