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Cheap Oil Gives Airline Stocks Some Lift

29 February 2016 in Trading Ideas

Key Takeaways

  • Airline stocks have shot higher in the past month in the wake of strong profit growth driven by lower fuel prices.
  • Airlines can now afford to step up the customer amenities, while trying to carve out new compelling service options.
  • Motifs mentioned: Taking Flight
  • Stocks mentioned: American Airlines Group Inc (NASDAQ:AAL), Delta Air Lines, Inc. (NYSE:DAL), Southwest Airlines Co (NYSE:LUV), United Continental Holdings Inc (NYSE:UAL), JetBlue Airways Corporation (NASDAQ:JBLU), Alaska Air Group, Inc. (NYSE:ALK).

While the plunge in oil prices has put many small- and medium-sized energy companies on the brink of disaster, it’s been a boon for industries that thrive on cheaper fuel.

Last month, American Airlines Group Inc (NASDAQ:AAL) said its profit surged in the latest quarter, capping a string of record fourth-quarter earnings reports by US carriers that were propelled by historically low fuel prices.1

American, the world’s largest airline by traffic, said net income soared to $3.28 billion in the latest period from $597 million a year earlier. Even excluding a large, noncash gain in the latest quarter and other one-time factors, profit rose 17% to $1.3 billion.

Delta Air Lines, Inc. (NYSE:DAL), the No. 2 US carrier, also reported a big fourth-quarter profit of $980 million, compared with a year-earlier loss of $712 million when it wrote off $1.2 billion in the value of its fuel hedges. Meanwhile, Southwest Airlines Co (NYSE:LUV), United Continental Holdings Inc (NYSE:UAL) and JetBlue Airways Corporation (NASDAQ:JBLU) all reported strong fourth-quarter results.

The reports have revived the fortune of airline stocks and related industry investments. The Taking Flight motif, for example, has gained 9.1% in the past month. In that same time, the S&P 500 has increased 2.9%.

Over the last 12 months, the motif has fallen 11.1%; the S&P 500 is off 7.4%.

According to the Wall Street Journal, the International Air Transport Association recently said that the further retreat of oil prices could prolong a period of growth in global air-travel that is above historic averages. Air travel is growing 6% to 7%, already above the norm, with the potential for low oil prices to produce a boost into 2017.

That’s not to say that low oil prices come pain-free.

Airlines have added flights and seats that weren’t profitable when fuel was pricier, causing fares to decline, the Journal reported. While that can spur US traveler demand, oil’s drop has gone hand-in-hand with a rise in the dollar, which makes tickets on US carriers more expensive for foreign buyers.

As a result, unit revenue—the important metric of how much an airline takes in from each passenger flown a mile—has been retreating for the past year. And that likely won’t improve until later in 2016 at the earliest, some airlines and analysts believe.

Several airlines warned of continued pricing pressures in their latest earnings reports. United said its traffic from energy-related corporate customers in its Houston hub fell 40% in the quarter, according to the Journal.

As a recent Investor’s Business Daily article pointed out, pricing-based competition also has airlines investing in things passengers don’t always notice: profit-sharing, reducing debt and investing in fuel-efficient planes. Those moves aim to keep carriers competitive in the long term, when oil prices come back up.2

“If you’re making a whole bunch of money right now, and you start giving everyone free meals and drinks, they’re going to get used to that,” Argus Research David Coleman told IBD. “So then when you cut them away when fuel prices go back up, they’re going to be screaming, ‘Why don’t I get my free rum and Coke?’ ”

Ironically (or perhaps not), this improved service comes as complaints from passengers jumped 30% in 2015, according to Transportation Department data cited by IBD.

To win more customers, Delta and United Continental are trying to draw more business travelers with on-time commitments. American Airlines and Alaska Air Group, Inc. (NYSE:ALK) are planning more comfortable “premium economy”-style seating.

JetBlue, meanwhile, is exploring ways to improve customer and operational service through Big Data and artificial intelligence.

Delta also has tested pre-loading carry-ons into overhead bins to hasten the boarding process. Cowen analyst Helane Becker told IBD that airlines may reconsider how they approach boarding and fees this year, saying airlines probably have their current fees backwards.

“They should have charged for overhead bin space and let you check your bag for free,” she said.

Still, checked-bag and other fees, which began when oil prices jumped, almost certainly aren’t going anywhere despite today’s low prices, as customers grow accustomed to fees, analysts say. Southwest still allows two checked bags for free as long as they are within certain weight and size limits.

Airline operators may continue to navigate the sweet spot of competitive pricing that lures demand without diminished margins. For now, however, investors seem to have decided that sustained low fuel prices are a decidedly positive development for airline stocks.

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  1. Susan Carey, “American Airlines’ Profit Soars, Propelled by Lower Fuel Prices,” wsj.com, Jan. 29, 2016.
  2. Bill Peters, “Airlines Keep Fees, Oil Windfall And Add Perks That Cost Peanuts,” investors.com, Feb. 19, 2016, http://www.investors.com/news/amid-recession-fears-airline-amenities-may-ride-out-the-chop/, (accessed Feb. 28, 2016).

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