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Airline stocks getting plenty of lift

24 October 2016 in Trading Ideas

Key Takeaways:

  • Airline shares have risen on plans by providers to tighten flight capacity.
  • Fuel prices are rising, and the fare wars are over for now.
  • Stocks mentioned: Delta Air Lines (NYSE:DAL), Southwest (NYSE: LUV).
  • Motifs mentioned: Taking Flight

Shares of airline companies haven’t produced for investors throughout most of the year, but the sector has gained altitude over the past six weeks as the industry has forecasted that skies are clearing for higher revenue.

Early last month, Delta Air Lines (NYSE:DAL) Chief Financial Officer Paul Jacobson said his airline would be the first of the three network carriers to report a positive year-over-year increase in unit revenue, a closely watched metric of how much an airline takes in for each passenger flown a mile.1

Negative unit revenue trends have been at the core of recent investor sentiment, which has been turbulent throughout the airline sector over the past 18 months as a series of fare wars weighed on average ticket prices and overshadowed the cost-cutting and selling of other perks and products that have helped airlines generate record profits.

Jacobson also pointed to an improving domestic fares environment that has been replicated in its Pacific and Latin American markets, though capacity additions on trans-Atlantic routes remained a challenge.

He added that the help to profits from lower fuel prices was over, and predicted that the fourth quarter of 2016 would be the first time in two years that airlines experienced a year-over-year rise in market fuel prices, excluding hedges.

As the Wall Street Journal noted, investors have remained wary of carriers diluting the benefits of cheaper fuel with pricier labor deals and expanded flying, but Jacobson said higher fuel “traditionally” allowed carriers to boost ticket prices and average revenue.

Part of the means to boost revenue comes from limiting capacity. Southwest (NYSE: LUV) said last month that it expected to expand capacity by less than 4 percent next year compared with 2016, less than most analysts expected.2

Plans to restrict passenger seats were also echoed by Delta just a month later, when the company’s CEO explained that the industry was enduring the weakest revenue environment in recent memory in a combination with higher fuel costs, which made capacity a key lever to navigate the headwinds. Delta is slowing capacity growth to 1% in the final quarter of the year and plans a similar increase for 2017, half the expected expansion this year.3

Delta said the moves would likely help its passenger revenue per available seat mile to turn positive early next year, and executives said the metric should be flat for domestic routes between November and December.

The move by airlines to put profitability ahead of growth has been welcomed by investors who grew weary of the long price war. The Taking Flight motif, for example, has risen 7.6 percent in the past month. In that same time frame, the S&P 500 has fallen 0.3 percent.

In the past 12 months, the motif has decreased 4.1 percent; the S&P 500 is up 4.9 percent. Delta and Southwest shares comprise more than a 34 percent weighting in the Taking Flight motif.

Future monthly traffic reports by airlines will be key for investors to determine if companies can deliver on their promise to boost unit revenue growth by restricting capacity. Success in that area could go a long way to extending the sector’s rally.

1,2Doug Cameron, “Airline Stocks Soar on Revenue Outlook,” wsj.com, Sept. 7, 2016.

3Joshua Jamerson and Doug Cameron, “Delta Expects Revenue Trend to Improve,” wsj.com, Oct. 13, 2016.