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What¿¿¿s in Store for U.S. Airlines Under Trump?

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Donald Trump’s election win in November turned out to be a boon for the stock market, with major indices skyrocketing. The airline space was not left behind, with the NYSE ARCA Airline Index gaining in double digits since Nov 8.

In fact, top airline executives met the President (who assumed office last month) on Feb 9, and had a constructive discussion, which led to airline stocks gaining. President Trump promised to modernize the obsolete U.S. air traffic control system. Airline companies are also hopeful that the Trump Era would see them operating with fewer regulations and in a low-tax regime.

No doubt, the airline space will be closely watched going forward.

Buffett Boost for Airlines

The prospects of the airline stocks were further boosted with Warren Buffett's recent interest in the space. Buffett’s Berkshire Hathaway increased stakes in airline heavyweights like American Airlines Group (AAL - Free Report) , Delta Air Lines (DAL - Free Report) and United Continental Holdings (UAL - Free Report) in the fourth quarter. Moreover, Buffett has invested heavily in low-cost carrier, Southwest Airlines (LUV - Free Report) .

Buffett’s renewed interest in the airline sector, after having shunned it for a long while, was made public in November last year. The recent increase of stakes by one the most revered investors of all time is certainly a healthy for the sector that had been grappling with multiple headwinds not so long ago.

Unit Revenues to Improve Further in 2017?

Woes related to unit revenues had plagued airlines for quite a while. However, the industry’s impressive fourth-quarter results have been able to mitigate such worries to some extent. In fact, carriers like American Airlines and Alaska Air Group (ALK - Free Report) displayed growth in this key metric in the fourth quarter. Alaska Air Group holds a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The first-quarter guidance for passenger unit revenues from the likes of Delta and United Continental is also encouraging. Given this bullish backdrop, more and more carriers are expected to return to unit revenue growth in 2017.

Moreover, the scenario of rising oil prices in 2017 provides airlines the scope to raise air fares, thereby boosting revenues. Reportedly, airfares were increased by the likes of JetBlue Airways (JBLU) and Alaska Air Group in January. We expect even more carriers to hike fare as the year progresses.

Valuation Signals More Upside

Going by the EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation and amortization) ratio, which is often used to value airline stocks, given their significant debt levels and highdepreciation and amortization expenses,the industry doesn’t look expensive at this point.
The industry currently has a trailing 12-month EV/EBITDA ratio of 6, which is favorable compared to what the industry saw in the last two years. The ratio is almost near the low end of 4.6 during the period.

Additionally, the reading compares favorably with the market at large, as the current EV/EBITDA for the S&P 500 is at 10.43 and the median level is 9.7. The industry’s favorable positioning compared to the overall market certainly signals more upside. 

Zacks Industry Rank

The airline industry falls under the broader Transportation sector (one of 16 Zacks Sectors). The bullish Zacks Industry rank of 67 carried by the 25-member Zacks Transportation-Airline industry also highlights the fact that airline stocks are back in favor. The favorable rank places the industry in the top 26% of the 250+ groups enlisted. The bullish stance on the industry is further augmented by the fact there have been 13 positive estimate revisions in the fourth quarter of 2016.

The improving scenario for the airline industry can be well gauged from the fact that the Zacks Industry Rank for the space has improved immensely, given the industry’s 200+ rank only a few months ago.

Some Headwinds

While there are plenty of reasons to be bullish about airlines moving ahead, the space is not entirely bereft of headwinds. With carriers inking deals with various labor groups, such costs are on the rise. This can be made out from the fourth-quarter earnings reports of carriers, which clearly shows that increasing costs led to significant contraction in their bottom line on a year-over-year basis. In fact, our Earnings Preview report shows that the transportation sector, of which airlines are a part, is one of the worst performers in the quarter among the 16 Zacks sectors.

The outlooks issued by various carriers for the first quarter seem to suggest that labor costs will hurt earnings in the first quarter as well. Additionally, on Jan 27, President Trump issued a ban on travelers from seven predominantly Muslim nations – Iraq, Iran, Syria, Yemen, Sudan, Somalia and Libya – from entering the U.S. The ban, said to be aimed at preventing terrorism, restricted travel from these nations for three months, apart from suspending the admission of refugees for four months.

As expected, the immigration ban spelled challenges for airlines stocks, as travel demand is likely to decline. However, with courts refusing to reinstate the ban, focus will remain on the issue going forward. Also, technical glitches have been a cause of concern for carriers with many heavyweights in the space having their services disrupted due to this issue.

Bottom Line

The sector’s cheap valuation, the faith given by one of the greatest investors of all time, improving unit revenue scenario and other tailwinds makes us believe that good things are in store for airlines in 2017. Moreover, in the event of President Trump being successful in revamping the U.S. air traffic control system and cutting taxes, already cheap airline stocks would fly even higher.

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