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Industry Outlook

There is no denying the fact that the recently outperforming sector has now fallen on hard times and is no longer a hot favorite amongst investors. The sector is grappling with a number of issues – surges in terror attacks, technological problems, labor strife and many more. However, there exist certain tailwinds that make airline stocks a worthwhile option in spite of the prevalent gloom. Let’s explore these tailwinds in detail.

Havana Approval – A Major Positive

On Aug 31, the U.S. Transportation Department (“DOT”) granted final approval to eight U.S.-based carriers to initiate commercial flights to the capital of Cuba. Following the final nod, carriers will be able to start operations shortly. The verdict confirmed the tentative approval awarded on Jul 7, 2016. The carriers that have gained the final approval include the likes of Delta Air Lines (DAL - Free Report) , American Airlines Group (AAL - Free Report) , United Continental Holdings (UAL - Free Report) , JetBlue Airways Corp. (JBLU - Free Report) , and Southwest Airlines Co. (LUV - Free Report) .

The popularity of Havana as a travel destination can be clearly made out from the fact that U.S. carriers had collectively applied for the approval to operate nearly 60 daily flights to the Cuban capital. However, only 20 daily roundtrip flights on the route were approved eventually. The permission for flights on the Havana route is a major positive, and once operational, the top line of the concerned carriers should be boosted significantly as the city is a favorite tourist spot.

The Havana approval came on the very day the first commercial flight to Cuba from the U.S. touched ground in more than 50 years. JetBlue had the honor of operating the first flight (387) which landed in Santa Clara, Cuba, from Fort Lauderdale on Aug 31. We note that the DOT had granted approval to six U.S.-based carriers to operate scheduled flights to nine Cuban cities (excluding Havana) in June this year.

Will Unit Revenue Woes Mitigate?

It is no secret that airline stocks have been hurt by unit revenues issues for quite some time. However, some recent favorable developments indicate that the issues might be mitigating. In its September traffic report, Delta Air Lines stated that its passenger revenue per available seat mile (PRASM: a measure of unit revenue) declined only 3% in the month. The reading compared favorably with July and August when PRASM declined 7% and 9.5%, respectively. In fact, Delta Air Lines expects to be the first network carrier to return to “positive unit revenue growth.”

Moreover, in the third quarter, revenue per available seat mile (RASM) at JetBlue decreased 3.5%.This indicates an improvement from the 8.2% decline in the second quarter.

Bullish Capacity-Related Forecasts

Fears related to overcapacity have been plaguing airline investors for quite some time. Apprehensions regarding airline capacity growth at a rate higher than the U.S. GDP leading to an oversupplied market also made investors jittery. However, airline stocks had a field day on Sep 7, courtesy of bullish capacity-related forecasts from the likes of Southwest Airlines at the 9th Annual Global Transportation Conference.

Dallas, TX-based Southwest Airlines projects 2017 capacity to expand less than 4% on a year-over-year basis. The projection compares favorably with the view for 2016, wherein capacity is estimated to increase in the range of 5% to 6%. The carrier further mentioned that most of the 2017 capacity growth (approximately 2 points) would come from domestic markets, while international expansion would account for 1–2 points.

While releasing its third quarter results, Delta said that 2017 capacity is projected to expand merely 1%, which is in line with the projection for the fourth quarter.

Cheap Oil

The biggest tailwind for airline stocks in recent times has been cheap oil. Low fuel costs have slashed the operating expenses of carriers significantly, supported huge savings and fortified the balance sheets of carriers. The strong cash balance has resulted in investor-friendly activities like more share buybacks and dividend payments. Moreover, employee-friendly activities like profit sharing have also been in vogue in the airline space. Carriers like Delta Air Lines are also looking to reduce their debt levels based on their improved financial position.

However, given that oil prices have been weak for an extended time period (since mid-2014) it is natural for the effect of cheap oil to be priced in. Consequently, this factor is not as defining for airline stocks currently as was the case a few months ago. However, oil price weakness continues to be responsible for year-over-year earnings growth of carriers in spite of its waning impact.

Currently, oil prices are hovering around the $50 a barrel mark, a long way off the above $100 a barrel mark reached two years ago. Despite the recent OPEC action, oil prices are unlikely to touch the highs of mid-2014 anytime soon. This factor will continue to aid these carriers’ bottom line, going forward.

In fact, Delta Air Lines had stated in September that even the scenario of rising oil prices could be favorable for airlines as it would provide the scope for increasing air fares, thereby boosting revenues.

IATA’s Bullish View Raises Optimism

The International Air Transport Association (“IATA”) provided a robust outlook for 2016.

At its Annual General Meeting in Dublin, the research firm raised the 2016 global net profit projection for the industry to $39.4 billion from $36.3 billion. Notably, the figure reported in 2015 was $35.3 billion. Global net profit margin is expected to expand to 5.6% in 2016 from 4.9% a year ago.

Interestingly, North American carriers are expected to generate the bulk (58.1%) of the profits in 2016. Carriers from other regions like Europe and the Middle East are expected to perform better in 2016 than the last year.

Also, Latin American carriers are anticipated to witness a healthy 2016 after a dismal 2015. These carriers are projected to register a profit of $100 million in 2016 as against a loss of $1.5 billion in 2015. We are also bullish on Latin American carriers as is reflected by the Zacks Rank #1 (Strong Buy) sported by Copa Holdings (CPA - Free Report) and GOL Linhas (GOL - Free Report) . You can see the complete list of today’s Zacks #1 Rank stocks here.

Moreover, a report recently published in Reuters indicatesthat the IATA is progressing well as far as recovery of revenues (in air fares) blocked in Nigeria are concerned. According to the report, the currently blocked amount is less than half of what the Nigerian economy owed to foreign carriers in June this year.

String of Earnings Beats in Q3

Despite the multiple tailwinds plaguing the sector, the airlines started the third-quarter 2016 earnings season on a strong note with many carriers outperforming on the bottom-line front. The carriers to have reported better-than-expected earnings in third quarter include the likes of Delta Air Lines, United Continental Holdings, American Airlines and Alaska Air Group (ALK - Free Report) .

In fact, carriers like United Continental Holdings, American Airlines and Alaska Air Group 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 for it.

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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