Back to top

Industry Outlook

Airline stocks have hit rough weather with a plethora of issues affecting the sector. These companies are currently exposed to multiple headwinds including a surge in terror attacks, technological problems, Brexit-induced uncertainty, capacity woes, rising labor costs and declining airfares to name a few.

As if the aforesaid risks were not enough, the emergence of Hurricane Matthew has added to the woes of the already challenged industry. The storm has caused extensive damage in the affected areas in the U.S. As expected, the natural calamity impeded travel with many carriers including Delta Air Lines (DAL - Free Report) , JetBlue Airways Corporation (JBLU - Free Report) and Alaska Air Group (ALK - Free Report) having to cancel flights/offer refunds owing to safety-related concerns. The bearish Zacks Industry Rank of 242 (among more than 260 groups) carried by the Transportation-Airline division further highlights the hard times the sector has fallen in.

Technological Glitches Raise Concerns

Over the past few months, some of the biggest airlines have been adversely impacted by technological issues. In August, Delta Air Lines had to suspend multiple flights and delay several others due to a power outage in Atlanta. The outage affected the computer systems, which in turn, disrupted the company’s operations worldwide. In fact, the outage crippled operations and led to in 2,300 flights being cancelled over a three-day time span, causing uncalled-for harassments to passengers.

The severity of the power outage at Delta Air Lines can be gauged by the fact that the disruption hurt the top line of the carrier in the third quarter to the tune of $100 million. The airline behemoth’s consolidated passenger revenue per available seat mile (PRASM: a key measure of unit revenue) declined 6.8% in the quarter with the outage affecting the metric significantly.

Dallas-based Southwest Airlines Co. (LUV - Free Report) experienced a computer failure in July which disrupted operations for three days and resulted in cancellations of around 2000 flights and delays of approximately 7000 flights.

Declining Airfares & PRASM

The continuous decline in airfares is another concern for airline stocks. According to research firm Hopper, airfares (domestic roundtrip) had declined to $216 in September. The firm predicts that domestic airfares will decline to $213 in October and hit a low of $210 in January.

Low fuel costs and capacity overexpansion are believed to be the primary reasons for the decline in airfares. While low air fares are favorable for fliers, it is a drag on the top lines of carriers due to their lesser profits. Declining airfares and the constant fall in unit revenues have collectively spelt doom for the major carriers.

Carriers have been affected by unit revenue issues for quite some time. In spite of efforts to bring about some improvement on that front, these issues are unlikely to diminish anytime soon. Lower fuel surcharges on international flights due to weak oil prices continue to hurt the top line of carriers. This is evidenced by the declining key revenue metric – PRASM: a measure of sales relative to capacity for a carrier.

We note that passenger unit revenues declined 6.8% year over year at Delta Air Lines in the third quarter. Consolidated PRASM declined 5.8% in the third quarter at United Continental Holdings (UAL - Free Report) . Both these carriers registered a decrease in earnings as well as revenues in the third quarter.

Revenues also declined on a year-over-year basis at American Airlines Group (AAL - Free Report) in the third quarter. Southwest Airlines expects revenue per available seat mile (RASM) to decrease in the band 4–5% in the fourth quarter compared with a 4.1% decline in RASM in the third quarter.

Although quite a few carriers managed to beat estimates this earnings season, there has neither been a notable stock price movement nor a revision in Zacks Rank for most of these companies. This clearly indicates that the prevalent headwinds have more than offset the bottom-line outperformance of these firms. For example, Southwest Airlines Co. carries a bearish Zacks Rank # 5 (Strong Sell) in spite of posting better-than-expected earnings this quarter.

You can see the complete list of today’s Zacks #1 Rank stocks here.

Rising Labor Costs

The improved financial health of carriers, courtesy of low oil prices over the last few years, has been noticed by their employees who are also eager to get a share of the pie. This has resulted in frequent pay-related labor deals and associated issues across the airline industry. With such talks/deals in vogue in the aviation space, labor costs have been on a rise.

Escalating labor costs hurt the bottom line of major carriers in the third quarter. In fact, the total operating expenses of American Airlines rose 5.2% in the third quarter to $9.2 billion, mainly because of the 15.3% increase in salaries and benefits expenses. The recent labor deals inked by the company were the primary factors contributing to the increase in costs. Expenses for salaries, wages and other benefits climbed 8% to $421 million for the low-cost carrier. This in turn hurt JetBlue’s third-quarter results.

Operating expense per available seat mile (CASM) – excluding fuel and profit sharing – increased 3.1% for JetBlue to 7.53 cents in the third quarter. Notably, JetBlue’s fourth-quarter projection indicates that the costs are likely to continue rising. The carrier expects the metric to grow in the band of 4.5% to 6.5% (including negative impact to the tune of 0.5% due to Hurricane Mathew). Southwest Airlines expects CASM – excluding special items and profit sharing – to increase in the band of 4–5% in the final quarter of 2016, which is much more than the 2.6% increase witnessed in the third quarter.

Various Disputes

It is a well-known fact that carriers regularly come across labor-related challenges that often impact their operations.  For example, Southwest Airlines has been in the news for labor unrest in recent times with some of its labor groups demanding the removal of certain top executives. 

Apart from labor-related troubles, airlines constantly face probes from regulatory authorities. American Airlines, along with Delta Air Lines, United Continental Holdings and Southwest Airlines, is being investigated by the Department of Justice on the possibility of unlawful co-ordination to limit the availability of seats with the objective of keeping airfares high.

Additionally, according to a report appearing in Reuters, the U.S. Department of Transportation fined four major U.S. carriers, including American Airlines and United Continental, in August for inaccurately informing passengers about compensation. According to the report, American Airlines was fined the maximum amount.

The ongoing dispute between leading U.S. carriers and their Gulf counterparts is another challenge for the industry. The uncertainty about Alaska Air Group’s proposed takeover of Virgin America (VA - Free Report) is another cause for concern.

Surge in Terror Attacks & Other Challenges

The unfortunate rise in terror attacks across the globe has justly raised concerns regarding security. In such a scenario, the top lines of carriers are likely to be hurt due to reduced demand for travel. Events like the mass shooting in Orlando, the suspected terror attack in Southern France, disappearance of the EgyptAir jet and the Brussels attacks have all severely hurt airline stocks due to waning travel demand. Such apprehensions were also reflected by the International Air Transport Association (IATA) projection of passenger travel growth (6.2%) in 2016 to be less than that recorded in 2015 (7.4%).

Moreover, the vote cast by Britons in June in favor of exiting the European Union has put U.S. carriers with exposure to the U.K. at risk.  For example, American Airlines has significant exposure to the country (6.2% of capacity). According to the IATA, with Brexit materializing, the U.K.’s air passenger market is expected to shrink in the band of 3–5% by 2020.

As if the above challenges were not enough, the outbreak of diseases like the Zika virus hurt demand for travel. A few months back, the Centers for Disease Control and Prevention (CDC) issued a travel warning following the outbreak of the mosquito-borne Zika virus in Miami. The outbreak prompted the CDC to issue an advisory for pregnant women to avoid the Zika-affected Miami neighborhood. Naturally, airline stocks were adversely affected due to a substantial decline in air travel.

Moreover, with economies like Venezuela and Nigeria in the doldrums, the airlines operating in the said nations (with dwindling foreign exchange reserves) are facing tough times with regard to repatriation. For example, Venezuela currently owes $3.8 billion to airlines.

Conclusion

The above challenges confronting the industry, unless addressed quickly, have the potential to hamper the growth prospects of stocks in the space. The headwinds can lead to investors, especially the risk-averse ones, shying away from investing in the sector.

Check out our latest Airline Industry Outlook here for more on the current state of affairs in this market from an earnings perspective, and how the trend is looking for this important sector of the economy now.


Confidential from Zacks

Beyond this Industry Outlook, would you like to see Zacks' best recommendations that are not available to the public? Our Executive VP, Steve Reitmeister, knows when key trades are about to be triggered and which of our experts has the hottest hand. Click to see them now>>