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Airline Industry Outlook - April 2018

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Airline stocks are unlikely to grab major headlines in the first-quarter 2018 reporting cycle, which will see reports from many sector participants in the coming days. High fuel costs are likely to limit bottom-line growth in the reporting cycle. Moreover, multiple flight cancellations due to foul weather is also likely to weigh on results.
 

In fact, high fuel costs have hurt the results of the two carriers — Delta Air Lines, Inc. (DAL - Free Report) and United Continental Holdings, Inc. (UAL - Free Report) — who have reported thus far. For example, fuel costs increased approximately 20% at Delta. Moreover, the winter storms hurt results to the tune of $44 million at this Zacks Rank #3 (Hold) Atlanta, GA-based carrier. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
 

In fact, oil prices have been on an uptrend lately and were up approximately 8% in the January-March period. We note that high oil prices do not bode well for companies in the airline space as fuel costs account for a significant chunk of their expenditures.
 

Given the inversely proportional relation between oil prices and airline stocks, this increase in crude prices is expected to hurt results for the carriers who are still to report their first-quarter numbers.
 

In fact, fuel prices are likely to be on uptrend this year. The International Air Transport Association (“IATA”) projects that jet fuel prices will escalate to around 12.5% to $73.8 per barrel in 2018. The fuel bill is likely to account for 20.5% of total costs in 2018 (18.8% in 2017). Apart from high fuel costs, expenses on the labor front and capacity-related woes represent further challenges for sector participants.
 

Zacks Industry Rank Supports Ongoing Struggles
 

The Zacks Industry Rank #177 (of 250 plus groups) carried by the Zacks Airline Industry highlights the fact that airlines are certainly not in favor, as far as investors are concerned. This unfavorable rank places the companies within the bottom 31% slot of the Zacks industries.
 

We classify our entire 250-plus industries into two groups: the top half (i.e. industries with the best average Zacks Rank) and the bottom half (industries with the worst average Zacks Rank).
 

Using a week’s rebalance, the top half beat the bottom half by a factor of more than 2 to 1 over the last decade.
Click here to know more: About Zacks Industry Rank

 

Not All Brickbats, Some Roses Too
 

Despite the above-mentioned headwinds, there are some factors that are favorable for sector participants. The unit revenue scenario is steadily improving, which is a huge positive for the sector. Riding on the improved scenario, the likes of American Airlines Group Inc. (AAL - Free Report) and JetBlue Airways Corp. (JBLU - Free Report) have issued bullish unit revenue views for the first quarter.
 

What is more encouraging is the fact that the bright scenario with respect to this key metric is unlikely to fade soon. For example, Delta expects total unit revenues, excluding refinery sales, to increase in the 3-5% range in the second quarter of 2018. Furthermore, rising fuel costs might lead to a rise in ticket prices and boost revenues.  
 

Strong demand for air travel also bodes well the sector. For example, Airlines for America (‘A4A’) — a premier trade organization — for U.S. carriers unveiled an upbeat forecast for the current spring season. Per the projection, airline companies are expected to profit considerably this spring (Mar 1-Apr 30) as travel demand is anticipated to increase 4% year over year.
 

Moreover, the new tax law (Tax Cuts and Jobs Act) is a positive for airlines and should boost profits of the participants of this key sector. Apart from boosting results, the new law should see an uptick in shareholder-friendly activities (dividends/buybacks) in the space. In fact, the likes of Alaska Air Group, Inc. (ALK - Free Report) and SkyWest, Inc. (SKYW - Free Report) have already announced hikes in their respective dividend payouts in 2018. We expect other carriers to follow suit in the wake of the Tax Cuts and Jobs Act.
 

The employee-friendly attitudes of most carriers can also be attested to their robust financial statuses. For example, in February 2018, Southwest Airlines Co. (LUV - Free Report) announced that it will pay $543 million to its employees as part of its 2017 profit sharing plan. This (the 44th consecutive profit sharing arrangement) is in addition to the bonus of $1,000 (to each eligible employee) declared last month, following the introduction of the new tax law. The 2017 payment equates to approximately 11.3% of each employee’s earnings in the year.
 

Moreover, the solid balance sheets of most carriers are allowing them to invest significantly in fleet upgrades. For example, American Airlines recently inked a fleet modernization deal worth $12 billion with The Boeing Company (BA - Free Report) . On the same lines, Hawaiian Airlines — the wholly owned subsidiary of Hawaiian Holdings, Inc. (HA - Free Report) — recently executed a non-binding Letter of Intent for buying 10 Boeing Dreamliners. The first of the fuel-efficient, lightweight Boeing 787-9 aircraft is expected to join its fleet in the first quarter of 2021. Moreover, Hawaiian Airlines has options to purchase 10 more such planes.
 

Valuation Picture
 

Even though, airlines are expected to put in a modest performance in the first quarter due to the above-mentioned headwinds, the valuation picture for the sector is attractive, highlighting a value-oriented path head. The industry currently has a trailing 12-month EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation and amortization) ratio of 6.5 — near the highest level of 7.4 seen in the last six months. The measure is often used to value airline stocks, given their significant debt levels, and high depreciation and amortization expenses.
 

When compared with its own average of 6.7 over that period, the industry doesn’t appear to have any upside. However, the space actually compares pretty favorably with the market at large, as the trailing 12-month EV-to-EBITDA for the S&P 500 is 11.6 and the median level is 11.8. The industry’s favorable positioning compared with the overall market calls for a solid upside in the quarters ahead.

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