Airlines scare me. Not in the usual way. Even given the recent troubles of Boeing (NYSE:BA) and their Dreamliner, I still understand that flying is safer than road travel. No, my worry is that airline stocks have been roaring.
The charts above for (clockwise from top left) Guggenheim’s Airline ETF (NYSE:FAA), Delta (NYSE:DAL), Southwest (NYSE:LUV) and US Airways (NYSE:LCC) all tell the same story of a sustained run up since around the middle of last year to new highs.
LCC is a slightly different case, as it has been boosted by talks of merger with the now bankrupt American Airlines, but a general improvement in the economy has been the main driver for the sector. Herein lies the contradiction that airlines always face. They need a robust economy to be successful, but a robust economy usually means that their biggest cost, fuel, is also rising.
Nymex crude oil has also responded to a clearer, positive economic outlook, rising around 10% since early December, and the recent pullback is starting to look like a mere pause in the upward move. Higher fuel costs affect most industries in some way, but, despite hedging strategies, they can be a killer for airlines’ profitability. In this era of people feeling that the industry is nickel and diming them to death, any fuel surcharge or fare increase is likely to meet with resistance from passengers, reducing the pricing power of airlines.
There are other structural problems that, over time, would indicate that the shake up in the industry is far from over. Virtual meetings and video conferencing are nothing new, but as a generation raised on digital contact ascend to positions of power it is reasonable to expect businesses to rely less and less on face to face meetings. A greater percentage of leisure travelers and less business customers just mean even more downward pressure on margins.
For some reason, the probability of the Us Airways/American merger has been talked about as a huge positive for the industry. There will be some synergy in domestic operations and a slight reduction in capacity, but anybody who believes that another merger involving a bankrupt airline is the answer is looking at history in a different way than me. In short, the future for airlines still looks bleak and the rally looks overdone.
If you own any airline or related ETF stock, now would be a great time to write some covered calls. If you don’t, shorting or buying puts on FAA could pay off fairly quickly. Whatever strategy you chose, be wary of airline stock when it is flying!