Stocks in the airline space had gained flight following the Dec. 4 decision of the Organization of the Petroleum Exporting Countries (OPEC) – the international cartel of oil producers – to not curb output of crude. However, the rosy run was short-lived. Stocks soon after suffered a major fall when Southwest Airlines LUV revealed a disappointing outlook with respect to its operating revenue per available seat miles (RASM: a measure of unit revenue) for the fourth quarter of 2015.
The Guidance and the Mayhem that Resulted
The Dallas, TX-based low-cost carrier said that it expects the key metric to be approximately flat to down 1% in the final quarter of 2015 on a year-over-year basis. We note that last month the carrier had predicted a 1% year over year rise in the fourth-quarter RASM. The new bearish outlook naturally caused shares of Southwest Airlines to slide 9.02% to $45.04 on Dec 8.
The damage was not limited to Southwest Airlines alone. Other major carriers like Delta Air Lines Inc. DAL, United Continental Holdings, Inc. UAL and American Airlines Group Inc. AAL too felt the heat and shed value on Dec 8. Consequently, it was no surprise that the NYSE ARCA Airline index declined 2.71% to $90.69 on the same day compared to the Dec 7 figure.
Projection Overshadows Strong November Traffic Report
Even though it was Southwest Airlines’ disappointing RASM guidance which sent shockwaves through the entire airline industry, we note that the carrier disclosed impressive traffic data for the month of November. Traffic or revenue passenger miles (RPMs) improved 13.9% year over year to $9.7 billion.
On a year-over-year basis, consolidated capacity or available seat miles (ASMs) increased 9.7% to 11.7 billion. Load factor (% of seats filled by passengers) improved 310 basis points to 83.2% (a record for the month of November) as traffic growth outpaced capacity expansion.
Soft Air Fares the Culprit?
Southwest Airlines, like many other carriers, is expanding capacity. Over the first eleven months of the year, capacity at Southwest Airlines has expanded 7.2%. The expiration of the Wright Amendment last year prompted Southwest Airlines to add more flights out of Dallas.
The bearish outlook with respect to RASM for the fourth quarter appears to be due to the low airfares. The weak airfare trend this year is evident in the data released by the Bureau of Labor Statistics. Airfares in Jul 2015 (on a seasonally adjusted basis) decreased 5.6% over Jun 2015. This decline marked the sharpest monthly drop since Dec 1995. Further, airfares declined 3.1% in the month of August.
Capacity Worries
Pricing and capacity worries have plagued airline stocks for most of 2015. The concerns originated in May 2015, courtesy Southwest Airlines yet again, which declared its plans to raise its capacity in the band of 7% to 8% in 2015. Following widespread investor panic, the carrier reverted to a 7% capacity growth plan and reiterated the same on its third quarter conference call.
The fact that capacity fears are not a thing of the past was reflected once more when shares of low-cost carrier JetBlue Airways Corporation JBLU declined on Oct 27 despite recording higher-than-expected revenues and earnings in the third quarter of 2015. The company voiced its expectation of a capacity increase in the band of 8.5% to 10.5% for the fourth quarter and in the band of 8.5% to 9.5% for full year 2015.
The prior guidance had hinted at a capacity expansion at the higher end of the 7% to 9% range. This increased capacity guidance for 2015 had triggered fresh capacity-related fears among investors, dragging the stock down.
Stocks in the airline space have also been hurt by the continuous decline in passenger RASM, a measure of sales relative to capacity for a carrier, throughout the year.
However, the extreme adverse reaction to Southwest Airlines’ RASM projection has been deemed an overreaction by some market watchers. With airlines benefiting substantially from low fuel costs, is there really a reason to worry?
Low Oil Prices: Major Growth Driver for Carriers
Despite the headwinds mentioned above, the low oil price environment makes airline stocks attractive. The weakness in oil prices, which has lasted for well over a year now, is nothing short of a godsend for stocks in the airline space. Operating expenses of these stocks have gone down considerably as fuel accounts for one of the major input costs of carriers. Weak oil prices have resulted in tremendous savings for the airline companies.
The massive savings have certainly cushioned the financial health of carriers. This has prompted the companies to launch share buyback programs, make increased dividend payments and significantly reduce their debt levels.
Currently, prices have fallen below the $40-a-barrel mark. This represents a significant decline from the approximate $105 per barrel that oil traded in July last year. On Dec 7, 2015, prices of U.S. crude plummeted to its lowest level in nearly seven years to $37.65 a barrel.
The persistent drop in oil prices has significantly boosted the bottom line of airline stocks over the past few quarters, helping them deliver solid outcomes on the earnings front. Carriers such as Delta Air Lines, American Airlines, Alaska Air Group, Inc. ALK, United Continental and Hawaiian Holdings Inc. HA recorded better-than-expected earnings per share in the third quarter of 2015.
Airlines Attract, Supported by Healthy Zacks Industry Rank
With airline stocks deriving benefits from the persistent weakness in oil prices, OPEC’s refusal to curb output despite the slump in prices means that the oversupply will continue to haunt the energy space. This implies that good times will continue for carriers.
The Zacks Industry Rank #72 for the “Trans-Airline” segment places it at the top 1/3rd of the 260+ member industry group and indicates the group’s near-term Positive outlook. With oil prices unlikely to touch the highs witnessed in mid-2014 anytime soon, airline companies should continue to display impressive bottom-line growth going forward.
Moreover, a higher demand for travel on the back of an improving labor market and consolidation are further reasons validating the bullish Zacks Rank on the airline industry despite the presence of headwinds such as the bearish RASM outlook at Southwest Airlines.
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