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Airlines Still Worth Considering: Here's Why

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Even though it is true that airline stocks are being confronted with multiple headwinds, all is not lost. There exist a few bright spots that still make investment in airline stocks worthwhile. Let’s delve into the details.

Oil Still Below $55 = Financial Prosperity

Despite the recent rally, oil prices are still hovering around the $50-a-barrel mark, a long way off the highs of mid-2014 when the commodity had traded in excess of $100 a barrel. As fuel costs represent one of the largest input costs for airline companies, the lower the oil prices, the better it is for sector participants. Lower oil prices imply greater financial well-being for airlines by virtue of massive savings.

Financial prosperity is reflected in the fact that the likes of Southwest Airlines (LUV - Free Report) , Delta Air Lines (DAL - Free Report) and Alaska Air Group (ALK - Free Report) have hiked their respective dividend payouts this year. Carriers have also indulged in share buybacks, which is more proof of their solid financial health.

Riding on balance sheet strength, some carriers have shelled out impressive amounts to employees as part of their profit-sharing programs. 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. For example, United Airlines, the wholly owned subsidiary of United Continental Holdings (UAL - Free Report) , announced in July, the introduction of Boeing 777-300ER service (the airline’s latest aircraft type featuring the all-new United Polaris business class seats) to additional routes.

Carriers are also investing substantially toward modernizing their respective fleet. For example, American Airlines Group (AAL - Free Report) invested $1.1 billion in a new aircraft during the second quarter of 2017. In fact, it aims to shell out $4.1 billion in the current year for the same purpose. Moreover, carriers like Delta and JetBlue Airways (JBLU - Free Report) are looking to reduce their debt levels based on their financial prosperity.

Bullish Readings

The global traffic data for July, released by the International Air Transport Association (“IATA”) raises optimism. Load factor (percentage of seats filled by passengers) touched record levels of 84.7% in July. The upside was due to the fact that traffic growth (6.8%) outpaced capacity expansion (6.1%) for the month. The favorable load factor reading highlights the fact that demand for air travel is strong.

Moreover, demand for air freight across the globe witnessed double-digit growth (11.4%) in July. This was, in fact, the fourth month out of five where double-digit demand growth was witnessed. The reading is well above the 10-year average growth rate of 3.1%. With growth in demand outpacing capacity expansion, the scenario bodes well for airline yields.

Traffic growth witnessed by the industry in the first half of 2017 was the highest in 12 years. Load factor also touched record levels. Additionally, at its 73rd Annual General Meeting in Cancun, Mexico, IATA stated that 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 global profits ($15.4 billion) is expected to come from the North American region.

Traffic data for the first half of 2017 released by the U.S. Department of Transportation’s Bureau of Transportation Statistics (BTS) also highlights the bullish case for carriers based in the United States. The BTS data states that a record number of passengers were transported by U.S.-based carriers in the period. The reading for load factor was also favorable.

Moreover, the busy Labor Day travel period (Aug 30-Sep 5) for U.S. airlines this year further highlights that demand for air travel remains strong. This bodes well for airlines.

Other Tailwinds

High labor costs have been hurting bottom-line growth for airlines for quite some time. Even though such costs will remain a hindrance, the good news is that the extent of their increase is expected to decline with time.

For example, American Airlines predicted in September that cost per available seat miles(excluding fuel and special Items) the year-over-year growth is likely to be around 3% in the final quarter of 2017. The metric had grown by 7.6% and 6.8%, respectively, in the first two quarters of 2017. The year-over-year growth for this measure of unit costs is likely to come down further to less than 2% in 2018/19.

Latin American carriers like GOL Linhas (GOL - Free Report) are seeing better times, buoyed by an improved economy. GOL’s view for full-year 2017 is impressive. We expect the company’s focus on capacity discipline to result in improvement in yields, going forward. GOL Linhas holds a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

European low-cost carrier Ryanair Holdings (RYAAY - Free Report) , which is being aided by its customer-friendly ‘Always Getting Better’ campaign, unveiled a busy London schedule for the summer of 2018, amid Brexit-related fears. The carrier aims to transport 24.8 million customers from three London airports — Stansted, Gatwick and Luton. With the Greek economy showing signs of revival, exciting times might be in store for Ryanair as it offers multiple flights to the Greek Islands.

To Wrap Up

The above commentary clearly suggests that despite headwinds, there exist enough reasons to be bullish about the industry’s prospects. Its solid fundamentals, suggested by its financial strength, highlight the fact that the sector should be able to overcome the current headwinds and fly high in the long run.

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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