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Reasons for Optimism on Airlines amid Geopolitical Tensions

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Fuel costs have been on the rise this year. Mounting tensions in the Middle East and the resultant fears of supplies being disrupted have resulted in a further increase in oil prices.

Despite headwinds like high fuel costs and capacity-related woes, all is not lost for airline stocks. There are still a few factors that make airline stocks attractive from an investment point of view. Let’s delve into the details.

Unit Revenues

The scenario pertaining to unit revenues – a measure of sales relative to capacity for a carrier – is steadily improving for airline stocks. In keeping with this improved scenario, the Atlanta, GA- based Delta Air Lines, Inc. (DAL - Free Report) , which kicked off the Q1 earnings season for airlines on Apr 12, reported a 4.3% increase in passenger revenue per available seat mile (PRASM: a key measure of unit revenues). Total revenues per available seat miles (TRASM: adjusted) also increased 5% (on a year-over-year basis) in the first quarter.

This Zacks Rank #3 (Hold) carrier expects impressive unit revenue growth in the second quarter as well. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Other airline players who will unveil results shortly also projected robust Q1 unit revenues on the back of strong demand for air travel coupled with improving yields. For example, American Airlines Group Inc. (AAL - Free Report) recently raised its unit revenue guidance and expects TRASM to increase between 3% and 4% year over year in the soon to-be-reported quarter (previous guidance anticipated the metric to grow in the 2-4% band).

Similarly, JetBlue Airways Corp. (JBLU - Free Report) expects revenue per available seat mile (RASM) to increase approximately 6.1% year over year (previous guidance anticipated the metric to grow in the 3.5-5.5% band). The metric was raised to the tune of 2.5 points owing to the timing of Easter in March.

Additionally, a lower completion factor due to the increase in flight cancellations boosted first-quarter unit revenues to the tune of approximately one point. Lower completion factor implies higher flight cancelations and a reduction in capacity. This, in turn, leads to an increase in unit revenues.

Labor Costs – Less of a Headwind

It is a well-established fact that high labor costs have been limiting 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. This is evident from the improved outlook provided by the key sector players with respect to cost per available seat miles (excluding fuel).

For example, American Airlines predicted that year-over-year growth for non-fuel cost per available seat miles (CASM) will be around 3% in the first quarter of 2018 compared with the previous projection that had hinted at a 4% increase.

Similarly, at Spirit Airlines, Inc. (SAVE - Free Report) , non-fuel unit costs are expected to decline approximately 5% in the soon-to-be reported quarter. The projection is better than the earlier view which had called for a 3% decline. Better operational performance contributed to the improved view.

Bullish Readings

The global traffic data for February, released by the International Air Transport Association (“IATA”) raises optimism. Load factor (percentage of seats filled by passengers) touched record levels of 80.4% in February. The upside was due to the fact that traffic growth (7.6%) outpaced capacity expansion (6.3%) for the month. The favorable load factor reading highlights the fact that demand for air travel is strong.

With growth in demand outpacing capacity expansion, the scenario bodes well for airline yields. Moreover, demand for air freight across the globe witnessed substantial growth (6.8%) in February.

Furthermore, the bullish projection pertaining to spring air travel by the Airlines for America (‘A4A’) — a premier trade organization — augments the fact that demand for air travel is strong, thus supporting the bullish case for airlines. According to the forecast, approximately 151 million passengers are anticipated to opt for air travel in the spring period (Mar 1-Apr 30). In fact, spring of 2018 is expected to be the busiest of all times for American carriers. The forecast is of 2.47 million fliers per day during the period, up 94,000 a day from the comparable year-ago figure.

Additionally, according to the Air Travel Consumer Report unveiled by the U.S. Department of Transportation for January, most U.S. carriers were more punctual in reaching their destinations compared with the year-ago figure. Moreover, the findings suggest that fliers were pleased as the number of complaints decreased during the month on a year-over-year basis.

Per the report, 79.6% flights operated by U.S. carriers touched down on time. This represents a marked improvement from the comparable figure of 76% in January 2017.

Improvement in the U.S. economy bodes well for travel-focused stocks like airlines. With consumer confidence remaining strong, more and more Americans are taking vacations. Further, affordable ticket prices are also favorable for consumers, who are being aided by a much-improved job market and rising disposable income.    

Other Tailwinds

Financial prosperity of airline players is reflected by the fact that they indulge in shareholder-friendly (dividends/buybacks) and employee-friendly (profit sharing) activities. 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, in a bid to modernize its fleet further, United Continental Holdings, Inc. (UAL - Free Report) announced in February the addition of Boeing 737 MAX 9 planes to its portfolio.

Their financial health of airline players is likely to improve further with the advent of the new tax law (Tax Cuts and Jobs Act). Consequently, an uptick in the shareholder/employee-friendly measures is very much in the cards in the airline space.

Additionally, Latin American carriers like GOL Linhas Aéreas Inteligentes S.A. (GOL - Free Report) are seeing better times, buoyed by an improved economy. The bullish factors surrounding airlines have prompted iconic investor Warren Buffett to show keen interest in airlines, which he earlier used to steer clear of.

Buffett, the world’s third richest man, has stakes in Delta, American Airlines, United Continental and Southwest Airlines Co. (LUV - Free Report) . Naturally, the interest shown in the space by one of the most revered investors of all times bodes well for this sector.

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 ahead for this important sector at the moment.

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