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February Airfares Decline, Excessive Competition a Reason

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Following a dismal start to 2016, with the S&P 500 and the Nasdaq declining 5.1% and 7.9% respectively in January, the scenario was better in February. The S&P 500 and the Nasdaq posted much smaller losses declining 0.4% and 1.2%.

The Dow, in fact, grew, albeit marginally, in February after declining 5.5% in January. The improved performances of the key benchmarks were in tune with the fortunes of the fliers with airfares declining 1.8% (on an unadjusted basis) in February as per data released by the Bureau of Transportation Services.

The decline in airfares has been attributed to the intense competition in key markets mainly among low-cost carriers. That fares in key markets would remain low in the first quarter of 2016 due to competition was stated in no uncertain terms by the Miramar, FL-based low-cost carrier Spirit Airlines (SAVE - Free Report) .

The significant growth of low-cost carriers like Spirit Airlines and Southwest Airlines (LUV - Free Report) has not gone unnoticed by legacy carriers including American Airlines Group (AAL - Free Report) and Delta Air Lines (DAL - Free Report) . In a price-conscious economy, it is not just the survival of the fittest, but of the cheapest. Keeping this in mind, big airline players are now looking to attract budget-friendly travelers.

Capacity and Pricing Woes Persist

The fears related to capacity and pricing have hurt stocks in the airline space for quite some time now. Fears that airline capacity would grow at a rate higher than the U.S. GDP, thereby resulting in an oversupplied market, have been one of the main challenges in the space.

Most of the February traffic reports released by carriers have shown that capacity growth has outpaced the rise in traffic thereby leading to a fall in load factor (% of seats filled by passengers). This clearly shows that fears related to capacity are not a thing of the past. Moreover, the relentless capacity expansion by low-cost carriers like Spirit Airlines has triggered a price war with legacy carriers hampering ticket revenues and yields.

Cheap Oil: A Double Edged Sword

That the bottom lines of carriers have expanded significantly due to plunging oil prices is a well-documented fact. Although oil prices are looking up lately, they are no where near the highs touched in mid-2014.

Soft oil prices have improved the financial health of carriers leading to a surge in buyback activities, increased profit sharing and more investments to improve travelers’ flying experience. Cheap oil has been the main reason behind the declining airfares. According to data released by the Department of Labor, airfares have seen a record downward revision in 2015 since 1987. Ticket prices fell by at least 15% in 2015 mainly on the back of low oil prices.

On the other hand, declining crude prices have hurt the top line of carriers who have struggled to post meaningful revenue growth over the past few quarters. While the strength of the US dollar has definitely been a dampener, lower fuel surcharges on international flights due to weak oil prices have also hurt the top line. This is reflected by the declining key revenue metric – passenger revenue per available seat mile (PRASM: a measure of sales relative to capacity for a carrier).

That PRASM woes will hurt carriers (legacy as well as low-cost ones) going forward too, is evident from the disappointing commentaries on the metric for the first quarter of 2016 by carriers like United Continental Holdings (UAL - Free Report) , Virgin America and JetBlue Airways Corporation (JBLU - Free Report) .

With fuel expenses likely to remain subdued going forward – as pointed out by the 2016 IATA forecast that fuel bill will fall to $135 billion, compared with $226 billion recorded only two years ago – we believe air fares will decline further in 2016. This implies good news for the passengers. So stay tuned for further updates on the burning issue.

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