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Why Airline Stocks Should Still Grace Your Portfolio

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It is a fact that stocks in the airline space have been confronted by multiple headwinds. These include margin issues as a result of rising expenses and ‘headline risks’ following the passenger fiasco at United Continental Holdings (UAL - Free Report) . United Continental carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Despite the challenges, there exist some factors that still make investment in airline stocks worthwhile. Let’s delve into the details.

Unit Revenue Scenario Vastly Improved

Woes related to unit revenues had palpably hurt airline stocks in the last couple of years. However, the scenario regarding the metric – a measure of sales relative to capacity for a carrier – has been improving.

For example, American Airlines Group (AAL - Free Report) , which has been displaying unit revenue growth since the fourth quarter of 2016, recently raised its guidance for total revenue per available seat miles (TRASM: a key measure of unit revenue) for the current quarter.

The Fort Worth, TX-based carrier now expects TRASM for the quarter to grow in the band of 3.5–5.5% (the previous guidance had hinted at a growth in 3–5% range). The Long Island City, NY-based JetBlue Airways Corp. (JBLU - Free Report) expects revenue per available seat mile (RASM) for the second quarter of 2017 to grow in the band of 4–6% (the previous guidance hinted at year-over-year growth in the band of 3–6%).

Delta Air Lines (DAL - Free Report) is also bullish on the metric. United Continental projects the metric to increase in the band of 1–3% in the second quarter.

Airfares & Capacity

Airline companies had been plagued by the issue of declining airfares for quite some time. Also, airfares decreased in almost every month of 2016, with the decline in July being the sharpest. However, in 2017 air fares are projected to rise. Hiking air fares, while not customer friendly, is consistent with the carriers’ objective of returning to unit revenue growth this year.

Moreover, most U.S. carriers are looking to curb capacity in 2017. For example, Delta has put the cap on 2017 system capacity growth at 1% in keeping with its objective of maintaining capacity discipline. According to a Bloomberg report, this year, capacity expansion for U.S. airlines is expected to be the least since 2013. This factor also supports air fare hikes in the current year.

Investor/Employee Friendly Measures Signal Financial Strength

It is a well-established fact that cheap oil has resulted in huge benefits for carriers by generating huge savings. Consequently, the balance sheets of carriers have been hugely strengthened. Shareholders have also reaped benefits from the solid financial positions of airline players.

Continuing its investor-friendly attitude, Delta increased its quarterly dividend by over 50% to 30.5 cents per share. The raised dividend will be paid to investors from the third quarter of 2017. Additionally, the board of directors approved a new share repurchase program worth $5 billion. The new share repurchase plan is expected to be completed by Jun 2020.

Along similar lines, low-cost carrier Southwest Airlines (LUV - Free Report) announced a 25% dividend hike to 12.5 cents per share (quarterly) together with a new buyback program worth $2 billion. Banking on balance sheet strength, some carriers have shelled out impressive amounts to employees as part of their profit-sharing schemes. For example, Delta paid more than $1 billion to its employees as part of its profit-sharing plan for 2016.

Additionally, the robust financial health of most domestic carriers has prompted them to invest substantially in improving the flying experience for travelers, in a bid to stay afloat in the competitive airline space.

A4A’s Bullish View

Airlines for America (“A4A”) – the largest airline trade association in the U.S. – has predicted that the three-month period (Jun 1–Aug 31) will be the busiest for U.S. carriers in terms of air travel. Strong demand for travel on the back of an improving economy is expected to drive passenger volumes to an all-time high.

Moreover, the volume (234.1 million) is likely to be 4% higher than the year-ago figure. In fact, the air travel projection for the summer translates into 2.54 million fliers per day, during the period. Apart from an improving economy, consumer confidence remains strong, resulting in more Americans going on vacations. Additionally, a much-improved job market and rising disposable income have given an added incentive for air travel.

In a bid to cope with the anticipated rush during the summer, Alaska Airlines, the wholly owned subsidiary of Alaska Air Group (ALK - Free Report) has started offering non-stop flights connecting Philadelphia and Portland, OR. The flights are operating on a daily basis from May 22 and will continue doing so until Aug 26.

Oil Still Below $50 a Barrel

Oil is currently hovering around $46 a barrel. While this represents a strong resurgence from the 12-year low of around $26 a barrel hit in Feb 2016, the fact that the commodity is trading at levels much lower than $100+ a barrel witnessed in mid-2014 still persist.

Moreover, it can be made out from Delta’s projection on fuel prices per gallon that oil prices are unlikely to touch such highs any time soon. The carrier expects the metric to vary in the range of $1.70–$2.00 in the 2017–2020 period.

Moreover, the Vienna decision of OPEC and some non-OPEC producers arrived in May 2017 to extend the current level of production cut until the first quarter of 2018 hurt oil prices. Lower oil prices mean good news for companies in the airline space.

Other Major Tailwinds

High hopes on the future of airline stocks are further raised by the fact that Warren Buffett – one of the most revered investors of all-time – is continuing to take interest in airline stocks. The Oracle of Omaha increased his stakes in American Airlines and Southwest Airlines in the first quarter of 2017 by 8% and 10%, respectively. The data is according to a regulatory filing by Buffett’s Berkshire Hathaway.

Furthermore, efforts of carriers to modernize their respective fleet by most carriers are encouraging. Additionally, carriers are looking to add new routes to widen travel choice.

Moreover, airline companies are also hopeful that the Trump era would see them operating with fewer regulations and in a low-tax regime. In a bid to modernize the obsolete U.S. air traffic control system, the President has proposed to privatize the nation’s air traffic control system.

Multiple Earnings Beats in Q1

Despite the headwinds, the Q1 earnings season did see quite a few airline players, including heavyweights like Delta, American Airlines Group and United Continental, outperforming on the bottom line.

The likes of United Continental Holdings and American Airlines have not only topped earnings expectations but have also outperformed in terms of revenues. This clearly suggests that in spite of the multiple issues currently confronting the airline sector, all is not lost.

Check out our latest Airline Industry Outlook for more news on the current state of affairs in this market from an earnings perspective, and how the trend looks for this important sector at the moment.

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