“A recession is when you have to tighten your belt; depression is when you have no belt to tighten,” British Caledonian Airlines founder Sir Adam Thomson once said. “When you’ve lost your trousers, you’re in the airline business.”
Airlines – and their investors – know the truth of those words. The airline business is a notoriously difficult place to make money. In the best of times, carriers balance on razor-thin margins. High costs, burdensome regulations, cutthroat competition, and the persistent risk of unexpected hazards place unrelenting pressure on airline operations.
Last year, the 11 largest U.S. airlines earned a combined $390 million — less than half a penny on every $1 of revenue generated for the year, according to the industry trade group Airlines for America (A4A). Those carriers included United Continental (NYSE:UAL), Delta (NYSE:DAL), American (PINK:AAMRQ), US Airways (NYSE:LCC), Southwest (NYSE:LUV), JetBlue (NASDAQ:JBLU), Alaska (NYSE:ALK) and Hawaiian Airlines (NASDAQ:HA).
That’s not a new development for the sector. From 2000 to 2009, U.S. airlines lost $54 billion, according to Berkeley economist Severin Borenstein. A 20% drop in air travel after 9/11 was part of the problem. Then, “because of the fixed capital costs and sticky labor costs, the decade of depressed demand was accompanied by a decade of depressed prices,” he wrote in a paper on airline losses.
Airlines have regained some of the altitude lost during the recession, but they still struggle mightily to make money. Here’s the good, the bad and the ugly of airline stocks right now:
The Good
The FAA forecasts that demand for air travel will double over the next 20 years, enabling most U.S. airlines to remain profitable over that time period. Between now and 2015, however, airlines will struggle with the economic challenges in Europe and volatile fuel prices, the agency says.
More positive news: Airlines are doing a better job in metrics of performance and customer service. In January, 83.7% of flights arrived within 15 minutes of scheduled arrival time — an all-time record for any January since the Department of Transportation (DOT) started keeping track in 1988.
The Bad
As airlines scramble to cut costs, boost efficiency and lure more-profitable business customers, replacing aging fleets with new aircraft has become a priority. New jets not only save on maintenance and fuel costs but they help make capacity planning easier and more profitable. Still, capital expenditures on modern aircraft are huge — a new Boeing (NYSE:BA) 737 MAX lists for nearly $80 million; a 787 Dreamliner lists for more than $193 million. If you prefer Airbus, an A320neo runs about $97 million, while an A380 superjumbo will set you back a cool $390 million.
Airlines typically cut deals that are far below list price or reduce capital costs through leasing or attractive financing arrangements, but that’s still big money. And don’t forget the people who fly the planes, maintain them and serve customers in the air and on the ground. Labor costs — including skyrocketing health and pension expenses — are eating many airlines’ lunch.
The Ugly
Since fuel is the largest single line item in an airline’s operating costs, the quest for fuel efficiency has become a necessary obsession. With a spike of $3 a barrel for Brent crude oil on Friday, it’s no wonder airline stocks slipped an average of 4% heading into the weekend.
Fuel accounts for more than a third of airline operating expenses — and every $1 rise in a barrel of Brent crude boosts airlines’ costs by $1.6 billion. In the past month, those prices have jumped nearly $6 a barrel.
Another factor: New fears that Israel may attack Iran over its nuclear program likely will keep prices high, at least in the short term.
Bottom Line: If airlines are such money pits, what could possibly be the attraction? Airline executives and plane-spotters alike point to the romance of flight, waxing eloquent in the vein of John Gillespie Magee Jr.’s ode to having “slipped the surly bonds of Earth and danced the skies on laughter-silvered wings.”
But in investments, as in most things, love and money seldom see eye to eye.
Since mid-2007, share prices of Delta, United and Southwest are down about 50%; US Airways is down over 90%. American, which filed for bankruptcy in November, was selling in the $30 range back then. Today the stock trades at 49 cents.
Trading Idea: The volatility in airline stocks makes them less attractive as a long play right now. But for the bold investor, put options on certain airlines might be an intriguing trading tactic — particularly for one of the sector’s most stellar players: Southwest.
Despite the fact that LUV has rewarded investors well for their faith, the airline will struggle in integrating AirTran in the coming months. Southwest shares closed at $8.31 on Friday and have been on a seesaw since last fall.
After the stock slipped to $7.39 before Thanksgiving, it rose to about $10 before slipping again. LUV has been trading sideways for the past couple of weeks. I’d look at the April 12 puts, expiring on April 20 — the $8 strike has the largest open interest.
As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned stocks.
