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Can Airline Stocks Stage a Comeback in 2018?

Gourav Kanti Bagchi
Airlines will increase domestic fares and reduce industrial capacity, which will likely benefit the sector.

The airline sector had a rough beginning this year, with the Dow Jones Transportation Average witnessing a significant decline during the first six months. However, recent figures tell a different story as both the Dow Jones Transportation Average and NYSE Arca Airline Index registered significant gains in the last few months.

A high level of domestic fares and low industrial capacity are expected to boost the airline sector. Also, some of the major airline companies are undervalued than the broader S&P 500. However, the recent surge in crude price remains a headwind for airline stocks.

High Fares, Low Capacity Are Boon for Airline Stocks

Recently, several airline companies announced plans to increase domestic fares and reduce capacity growth in order to counter rising fuel prices. After all, American Airlines Group Inc. AAL has already decided to terminate as many as 11 flight services, including the one between Chicago and Shanghai this October as the route, resulted in "colossal loss” due to rise in fuel prices. Similarly, the Fort Worth-based airline giant also earlier canceled flight service between Chicago and Beijing.

Managing director of investment banking company, Imperial Capital, Michael Derchin said that airline giants like Delta Air Lines, Inc. DAL will gain from “lower industry capacity and potentially higher domestic fares.”

Senior research analyst of financial services firm, Cowen Group, Helane Becker said that "low fares in the US domestic market” started to move higher and airlines are focusing on increasing “fares in the premium cabin." Becker further added that fare hike in the premium cabin will “begin to be reflected in revenue."

Airlines Less Pricey Than S&P 500, Tech Sector

Along with a positive industry outlook for the airline sector, several of its key components bear lower valuation levels. The recent price-earnings (P/E) ratio of the S&P 500 is 16.71, while that of the Technology Select Sector SPDR (XLK) is 18.66. As compared to the S&P 500 and one of the best performing sectors of the S&P 500 so far this year, airline companies are clearly undervalued.

Companies like Delta Air Lines, American Airlines, United Technologies Corporation UTX and Southwest Airlines Co. LUV have a P/E ratio of 9.24, 7.53, 9.46 and 12.91, respectively. A low level of valuations and strong growth prospects in the near-term make these airline stocks wise investment choices.

Delta Air Lines, United Technologies, and Southwest Airlines carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank stocks here.

Airlines Capable of Containing Rise in Oil Prices

Per the Energy Information Administration (EIA) on Aug 22, the U.S. crude inventories dropped by 5.8 million to 408.4 million barrels for the week ended Aug 17. Additionally, concerns remain that Iran would be forced to curb its oil imports on latest sanctions by the United States. Following these developments, oil prices surged.

Although a continued increase in crude oil prices is a threat for airline companies, their initiative to reduce industry capacity and raise domestic fares is aimed at countering this concern. Delta Air Lines, American Airlines, and Southwest Airlines have gained 10.2%, 3.7% and 17.5%, respectively, in the past one month.

Additionally, after the initial pullback this year, the Dow Jones Transportation Average (DJT) and NYSE ARCA Airline Index (XAL) have gained 5.7% and 2.6%, respectively, in the last three months.

Summing Up

Undoubtedly, the airline sector has come a long way from its weak start this year. Several major airline giants announced their increase their domestic fares and lower industrial capacity, which in turn is expected to boost the airline sector revenues. Along with this improvement, low valuation will also benefit these airline stocks to overcome high fuel costs.

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