Investing in Airline Stocks a Winning Strategy? - Industry Outlook
Overall, the airline sector is witnessing a robust period courtesy of weak oil prices that are assisting profitability. The Ebola-centric health scare that weighed on the group last year has also since lost most of its sting.
With respect to earnings, most stocks in the space reported better-than-expected earnings in the fourth quarter of 2014 riding on the favorable trends within the industry. Airline stocks such as Delta Air Lines (DAL), Southwest Airlines (LUV), Spirit Airlines (SAVE), Virgin America (VA) and Allegiant Travel Company (ALGT) delivered higher-than-expected earnings while also outpacing the Zacks Consensus Estimate on the revenue front.
Recent Price Fluctuations Not a Concern
Airline stock prices have been volatile lately, with day-to-day fluctuations in oil prices weighing on performance. The strength of the dollar has also resulted in stocks taking a downward turn, as a strong dollar is generally considered a net negative for the demand for travelling into the U.S. However, we are not too perturbed by the decline and consider it a short-term phenomenon. We believe fundamentals of the airline industry are strong and consequently, stocks in the space should eventually gain over the longer term.
Salient Positive Features of the Airline Industry
Mergers & Acquisitions: Companies in the airline space often resort to mergers to increase/restore profitability. In addition, mergers help carriers to expand their portfolio. The industry has seen multiple mega mergers, like the ones between Northwest Airlines and Delta Air Lines in 2008, United Airlines and Continental Airlines in 2010, and AirTran Holdings and Southwest Airlines Co. in 2011.
More recently, the merger of AMR (American Airlines' parent group) and US Airways created the American Airlines Group Inc. (AAL) in 2013. The merger, which occurred after a bankruptcy filing by American Airlines, resulted in the formation of the largest airline internationally. Evidently, the carrier has been making substantial profits ever since the merger took place.
Merger-driven consolidation has played an important role in the airline industry, limiting competition. Moreover, operating efficiencies have also largely improved following such mergers. According to a report in the Associated Press, post the mergers in the industry, more than 80% of the travel market in the U.S. now stands dominated by four major carriers, namely United Continental Holdings, Inc. (UAL), Delta Air Lines, Southwest Airlines and American Airlines Group. This consolidated industry is proving to be a lot more disciplined in adding capacity than has been the industry’s historical track record.
Route Additions: Airline companies have consistently added new routes to capitalize on increased demand for air travel. For example, Southwest Airlines Co. announced in Mar 2015 that it will operate daily non-stop flights between Baltimore and San Jose and a seasonal flight between Aruba and Houston every Saturday till Aug 8, 2015. After operating for several decades within the U.S. domestic market, Southwest Airlines initiated its international service in Jul 2014 with flights to Aruba, the Bahamas and Jamaica in the Caribbean.
In Feb 2014, JetBlue Airways (JBLU) announced that it will introduce nonstop flights (twice a day) from Baltimore to Fort Lauderdale, FL. The low-cost carrier intends to launch the new service from November this year.
The expiration of the Wright Amendment, which governed traffic at Dallas Love Field (Southwest‘s home base), has also benefited carriers like Southwest Airlines.
Infrastructural Improvements: The robust financial health of most domestic carriers has prompted them to invest substantially toward improving the flying experience for travelers, in a bid to stay afloat in the competitive airline space. American Airlines announced last year that it will invest in excess of $2 billion to upgrade its flying facilities. In the same vein, Delta Air Lines introduced a new five-tiered seating plan from Mar 1, 2015.
Emergence of Smaller Carriers
Another characteristic typical to airline industry is the emergence of low-cost carriers. Although consolidation within the U.S. aviation industry will cut down on competition, it is expected to be a temporary effect owing to low barriers to entry within the same.
Further, the improving profit margins in the industry have allowed smaller operators to expand considerably. Spirit Airlines Inc., which went public in 2011, has been performing reasonably well on lower crude prices and its discount model. Shares of Spirit Airlines have come a long way, increasing significantly from the IPO price of $12.
The latest U.S. low-cost airline to go public is Virgin America. The carrier, partly owned by British billionaire investor Richard Branson, commenced trading in Nov 2014. The company had made an impressive debut on the Nasdaq, raising $307 million through the offering. The stock has been using the proceeds primarily for general corporate purposes.
We note that Virgin America has seen troubled times ever since its launch in 2007. The company witnessed profits for the first time in 2013 since inception. Subsequently, the carrier went on to file a registration with the U.S. Securities and Exchange Commission (SEC) in July 2014 to launch its IPO.
Ireland-based Ryanair Holdings (RYAAY) is another low-cost airline which has been performing well. The recent decision of its board to approve plans to connect destinations between the U.S. and Europe at lower fares is, in our view, a key positive.
The Bottom Line
With oil prices expected to remain weak and ticket prices not showing substantial change, airline stocks should appreciate going forward. Therefore, adding airline stocks such as Southwest Airlines, Spirit Airlines, Virgin America and Allegiant Travel Company to your portfolio could prove to be a winning strategy. The stocks, apart from boasting strong fundamentals, are also witnessing positive estimate revisions.
Check out our latest Airline Industry Outlook here for more on the current state of affairs in this market from an earnings perspective, and how the trend is looking for this important sector of the economy now.
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VIRGIN AMERICA (VA): Free Stock Analysis Report
UNITED CONT HLD (UAL): Free Stock Analysis Report
SPIRIT AIRLINES (SAVE): Free Stock Analysis Report
RYANAIR HLDGS (RYAAY): Free Stock Analysis Report
SOUTHWEST AIR (LUV): Free Stock Analysis Report
JETBLUE AIRWAYS (JBLU): Free Stock Analysis Report
DELTA AIR LINES (DAL): Free Stock Analysis Report
ALLEGIANT TRAVL (ALGT): Free Stock Analysis Report
AMER AIRLINES (AAL): Free Stock Analysis Report
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