Airline Stocks Up on Southwest's Trimmed Capacity Outlook - Analyst Blog
Going by the events over the last couple of weeks, it seems trading in the airline space is being strongly influenced, albeit temporarily, by Southwest Airlines Co.’s LUV updates on its capacity growth outlook in 2015. Two weeks after the company projected capacity growth (measured in available seat miles or ASMs) in the range of 7% to 8% (earlier projection had called for 7% growth), CEO Gary Kelly scaled down the guidance to the original forecast of 7%.
The low-cost carrier’s May 19 announcement on capacity expansion had triggered off a major sell-off in the airline space. However, two weeks later, its decision to limit capacity growth received a warm welcome from investors, leading to most aviation stocks gaining value on Jun 1.
Not only was Southwest Airlines up 2.37%, its peers including the likes of Delta Air Lines, Inc. DAL, American Airlines Group Inc AAL, United Continental Holdings, Inc. UAL and Alaska Air Group, Inc. ALK were all impacted positively by the news. With airline stocks in the ascendancy, the NYSE ARCA Airline index gained 1.48% on the first trading day of June.
Why Such a Big Deal?
Southwest Airlines deliberately trimmed its capacity growth outlook to soothe the nerves of investors in the airline space. This is because the carrier’s May 19 comments at the Wolfe research global transportation conference citing plans to increase capacity had set off sparks, leading to widespread panic among investors. This, in turn, had caused major stocks in the airline space to nosedive.
Southwest Airlines’ projection had triggered an alarm among investors who feared that airline capacity growth at a rate higher than the U.S. GDP would hurt the sector’s capacity discipline apart from resulting in an oversupplied market. Investors anticipated that the capacity additions could eventually result in a possible price war between legacy and low-cost airlines (read more: Air Stocks and ETF Plunge).
Meanwhile, American Airlines Group’s CEO Doug Parker stated that the carrier intends to compete aggressively against the capacity expansion of discount carriers like Southwest Airlines and will not lose customers on pricing grounds. However, most market watchers had termed the sell-off, which caused a loss of approximately $10 billion in market value on May 20, a mere overreaction.
Southwest Airlines’ increased outlook sent airline stocks, which had otherwise been enjoying a healthy run over the past few months thanks to low oil prices, into a six-day losing streak. This marked their worst performance since Oct 2014 when airline stocks had crashed due to Ebola fears.
What Prompted Southwest to Revert to Old Outlook?
The widespread panic which had gripped investors prompted Southwest Airlines to toe the more investor-friendly line. Consequently, the carrier reverted to the capacity growth outlook of 7% for 2015 which it had originally provided in April this year. In addition, the airline stated that it intends to boost its 2015 target for return on invested capital (ROIC) as it believes that its historical ROIC figure of 15% is “too low”.
Moreover, the carrier projected that given the U.S. economy’s lower-than-expected growth rate, its passenger revenue per available seat mile (PRASM: a measure of unit revenue), will be down by approximately 3% year over year for the quarter ending Jun 30, 2015. We note that many other carriers like Spirit Airlines SAVE have predicted a lower RASM in the second quarter. Low-cost carrier JetBlue Airways Corp. JBLU, however, is a notable exception to this trend.
The Bottom Line
In view of Southwest Airlines’ latest revision in its capacity growth projection, we expect the investor panic, deemed as an overreaction in the first place, to come to an end. Not just that, we expect airline stocks to retain their upward momentum going forward as oil prices continue to stay weak.
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