Airline stocks did not set the stage on fire with their performance in the first quarter of 2017. In fact, it was nothing more than moderate with headwinds like high costs restricting bottom-line growth. With labor deals very much in vogue in the airline space, it is not much of a surprise that those costs are surging. This apart, the increase in fuel prices from year-ago levels have also spoiled the earnings picture.
Stocks in the airline space have been hurt by customer-related issues. The passenger dragging incident at United Airlines, the wholly owned subsidiary of United Continental (UAL - Free Report) , on Apr 9, drew criticism from across the globe, resulting in multiple apologies by the company. United Continental carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
The likes of American Airlines Group (AAL - Free Report) and Spirit Airlines (SAVE - Free Report) have also faced passenger-related issues of late.
President Trump’s goals of reversing the Cuba policy, set in motion by his predecessor President Obama, and widening the laptop ban are also serious threats to airline stocks.
Despite the above headwinds, there are plenty of factors to be bullish about the space. Let’s delve a bit deep to unearth those factors.
Improving Unit Revenue Scenario Bodes Well
Investors interested in the airline space closely watch the performance of a stock with respect to unit revenues — a measure of sales relative to capacity for a carrier. While it is true that woes related to the metric had hurt the sector significantly in the recent past, the scenario has improved now.
For example, American Airlines has displayed growth with respected to total revenue per available seat mile (TRASM: a key measure of unit revenues) since the fourth quarter of 2016. It recently issued a bullish forecast on TRASM for the second quarter of 2017. American Airlines expects to perform well on the unit revenue front for the rest of 2017. The likes of JetBlue Airways Corp. (JBLU - Free Report) have also issued bullish forecasts for this key metric for the second quarter.
Moreover, the scenario of rising oil prices in 2017 provides airlines the scope to raise air fares, thereby boosting revenues.
The strong balance sheets of major carriers have enabled them to engage in shareholder and employee-friendly activities. In keeping with this trend, Delta Air Lines (DAL - Free Report) and Southwest Airlines (LUV - Free Report) announced hikes to their quarterly dividend payouts by 50.6% and 25%, respectively. Moreover, both carriers announced fresh buyback plans.
Additionally, the prevalence of profit sharing schemes highlight the amiability of carriers. The solid financial health of airline players has led to increased investments aimed at improving flying experience of passengers.
Now, oil prices are currently much higher than the 12-year low of around $26 a barrel touched in Feb 2016, but are unlikely to touch the highs witnessed in mid-2014 any time soon. In fact, oil prices recently declined to below $50 a barrel as members of OPEC and some non-OPEC producers announced their decision to extend the current level of production cut until the first quarter of 2018. Lower oil prices imply greater savings for airlines, which in turn strengthen their balance sheets.
At its 73rd Annual General Meeting in Cancun, Mexico, the International Air Transport Association (IATA) said that despite rising fuel prices and labor costs, airline companies are expected to be more profitable in 2017 than previously expected. IATA now expects global net profit for the industry to come in at $31.4 billion (the earlier projection hinted at profits of $29.8 billion for 2017). The bulk of the global profits ($15.4 billion) are expected to come from the North American region.
The improved projection was driven by expectations of higher demand. While air travel is expected to grow 7.4% on a year-over-year basis, cargo demand is projected to grow 7.5% in 2017.
The rosy picture painted by the IATA for North American carriers is backed by the forecast provided by Airlines for America (‘A4A’). According to the projection, the three-month period between June and August will be the busiest one for the U.S. carriers in terms of air travel.
Zacks Industry Rank Highlights the Favorable Scenario
The positive developments are reflected by the bullish Zacks Industry Rank of 63 carried by the 25-member Transportation- Airline ndustry. The airline industry falls under the broader Transportation sector (one of 16 Zacks Sectors).
The favorable rank places the industry in the top 25% of the 250+ groups enlisted. The positioning indicates a positive outlook. In fact, our back-testing shows that the top 50% of the Zacks ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
To learn more visit: About Zacks Industry Rank.
Valuation Signals More Upside
The bullish Zacks Industry Rank is well supported by the segment’s attractive valuation. 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 high depreciation and amortization expenses, the industry doesn’t look expensive at this point.
The industry currently has a trailing 12-month EV/EBITDA ratio of 7.9X, which is better than what the industry saw in the last five years. The ratio is almost near the low end of the 5-year range. The industry also compares favorably with the broader market on the same valuation metric.
The sector’s attractive valuation, improving unit revenue scenario, bullish projections and other positives makes us believe that despite some headwinds, 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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