Citing concerns of rising costs, the global airline association, The International Air Transport Association (IATA), has trimmed its profit cost for 2018.
Per IATA global airlines net income has decreased by 12% to $33.8 billion for 2018, led by factors such as an increase in interest rates, and higher labor and fuel costs.
Though a buoyant U.S. economy and rising consumer confidence should boost passenger traffic volumes, other factors such as geopolitical risks, high taxes and strict regulations should be a dampener for the industry that has declined 13% year to date compared with the S&P 500’s growth of 2.3%.
Decline in Profit Forecast
The current profit forecast of $33.8 billion translates into a year-over-year decline of 11%, from net income of $38 billion earned in 2017. The industry was a beneficiary of tax credit last year.
These profit forecasts translate into thin margins of just 4.1% from sales expectation of $750 billion.
Per the IATA director, 4% is not a big number given that the industry is fragile with limited capacity to absorb shocks.
High Fuel Cost
An increase in oil prices is playing spoilsport for the industry. Per a recent report by Reuters Saudi Arabia, other OPEC (Oil and Petroleum Exporting Countries) countries, and non-OPEC allies led by Russia are likely to abide by a global pact on cutting oil supplies till the end of 2018. However, oil producers will make gradual adjustments in the event of any supply disturbances.
News had also circulated that OPEC and Russia are planning to increase crude oil production by 1 million barrels a day to neutralize the effect of shortfall of oil production from Iran and Venezuela, pushing oil price down, for a short while. However, strong international demand for crude oil, tight global oil inventories and stabilization of oil production should boost oil price in the near term.
IATA expects an average oil price of $70 a barrel this year, north of $54.90 last year and up from its previous prediction of $60.
Increasing Labor Cost
Labor cost has persistently been on the rise due to lack of skilled workers and qualified pilots. Per IATA, in 2016, labor cost surpassed fuel cost (22% and 21% respectively, of costs). This was a reversal of the earlier trend, when fuel costs accounted for the maximum expense. In 2018, IATA expects labor cost to be 30.9% versus 20.9% for fuel of total cost.
Going forward, it would be difficult to control labor cost. Suppliers and personnel are demanding an increase in payments due to strong profitability sustained by the industry in the past three years.
Rise in Maintenance Cost
A recent report by Oliver Wyman stated that cost of maintenance may rise on increasing labor and fuel costs. Operators may face higher costs for maintenance as well, with both wages for aircraft technicians and prices of aircraft parts and replacements on the rise.
Thus despite an increase in revenues from a higher number of fliers (passenger demand is expected to grow 7% this year on the back of stronger economic growth), the cost pressure should weigh on the bottom line. With demand staying in the positive zone, the real trick for airline companies will be to effectively manage their costs.
Stocks to Avoid
After several years of record profits the cycle seems to be peaking. With things not looking too optimistic for the industry, we choose to stay away from this space.
Here we point out Sell-rated stocks that have underperformed the industry and have also witnessed a negative estimate revision.
Southwest Airlines Co (NYSE:LUV), with a Zacks Rank # 4 (Sell)has seen the Zacks Consensus Estimate for current-year earnings being revised 2.2% downward over the last 30 days. The stock has lost 22% year to date.
Ryanair Holdings plc (NASDAQ:RYAAY) carries a Zacks Rank #5 (Strong Sell). The company has seen the Zacks Consensus Estimate for current-year earnings being revised 3.9% downward over the last 30 days. The stock has lost 2% in the past three months.
Controladora Vuela Co de Aviacion S.A.B. de C.V. (NYSE:VLRS) carries a Zacks Rank #5. The company has seen the Zacks Consensus Estimate for the current year decline to a loss of 42 cents from earnings of 26 cents, 30 days ago. The stock has lost 35% year to date.
JetBlue Airways Corporation (NASDAQ:JBLU) carries a Zacks Rank #4. The company has seen the Zacks Consensus Estimate for current-year earnings being revised 2.7% downward over the last 30 days. The stock has lost 16% year to date.
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