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Will Fuel Price Limit Sky Profits?

Zacks Equity Research

Fuel price volatility is the major threat to the airline industry. Fuel prices, though high currently, remain well below the 2008 level of over $140 per barrel that had ravaged the airlines industry. Even a small change in fuel prices can significantly affect profitability. Projecting this key variable with any level of accuracy has always been extremely challenging.

Airlines stocks tumbled yesterday on the rising crude oil price, which directly influences the cost of jet fuel that accounts for one-third of the overall expense. Crude oil jumped to a nine-month high above $106 per barrel after Iran cuts supply to Britain and France owing to the growing dispute over the Middle Eastern country's nuclear program.

US Airways Corp. (LCC) shares plunged the most with an 11% decline, followed by a 9% fall at United Continental Holdings Inc. (UAL) and JetBlue Airways Corporation (JBLU). The shares of Delta Air Lines Inc. (DAL) and Southwest Airlines (LUV) slumped 7% and 3%, respectively.

The fall in share prices might be temporary as the carriers are taking several steps to regain their lost profitability. Fare hikes and fuel hedging are the most effective tools to abate the negative impact from fuel prices.

The companies’ ability to pass along the increased costs of fuel to their customers is limited by the competitive nature of the airline industry. However, the carriers have been successful until now in passing along the higher prices to customers in the form of fare hikes.

Hedging strategies provide a cushion to the rising fuel prices and is being used extensively by most of the air carriers. US Airways does not hedge its estimated fuel consumption and is thus more vulnerable to price escalation than its rivals.

Moreover, the carriers are cutting capacities and adding new features to their services as well as introducing new products, which will enhance their value and profitability. These measures will fuel revenue growth and reduce non-fuel costs.

Air carriers are further focusing on fleet right-sizing. Though initially expensive, this seems the correct strategy to lower non-fuel costs. Air carriers are replacing their older fleet, which are no longer feasible in a fuel-expensive environment, with a new fuel-efficient aircraft.

Hence, we will be carefully watching whether the cost-cutting measures and several initiatives will help airlines to overcome the rising fuel prices. Thus, we are maintaining our long-term Neutral recommendation on Delta, United Continental, Southwest and JetBlue. For the short term (1–3 months), JetBlue retains the Zacks #2 Rank (Buy) while the rest hold the Zacks #3 Rank (Hold).

Read the Full Research Report on LUV

Read the Full Research Report on LCC

Read the Full Research Report on JBLU

Read the Full Research Report on DAL

Read the Full Research Report on UAL

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