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3 Airline Stocks to Buy Despite Ongoing Industry Turbulence

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It is a well-documented fact that stocks in the airline space are undergoing troubled times, being confronted with multiple headwinds. The performance of the players in the space in the Q1 earnings season further corroborates the above statement.

Lowered Bar Facilitates Earnings Beats

Despite the headwinds, the Q1 earnings season did see quite a few airline players including heavyweights like Delta Air Lines, Inc. (DAL - Free Report) , American Airlines Group (AAL - Free Report) and United Continental Holdings (UAL - Free Report) outperforming on the bottom-line front. All the above-mentioned stocks carry a Zacks Rank # 3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The conservative nature of the Zacks Consensus Estimate due to multiple downward revisions facilitated the earnings beats. For example, the Zacks Consensus for the first quarter of 2017 at Delta Air Lines was 57 cents per share which was much less than the year-ago figure of $1.18. Naturally, the lowered bar made it easier for companies to surpass the Zacks Consensus Estimate in Q1.

Higher Costs Distort Q1 Earnings Picture

Despite the fair share of earnings beat, growth on the bottom-line front was hardly visible in Q1 for airlines due to high costs. For example, Q1 earnings at Delta Air Lines contracted 41.7% on a year-over-year basis due to higher costs. At United Continental, the bottom line declined 66.7% year over year.

With airline players constantly inking deals with various labor groups, it is of little wonder that labor costs are surging thereby hurting the bottom line. Apart from this, fuel costs too increased and resulted in bottom-line contraction. For example,  at American Airlines total operating expenses climbed 11.4% year over year to $9 billion primarily due to the rise in fuel costs.

Expenses pertaining to salaries and benefits were also up 6.5%. Consolidated operating costs per available seat miles (CASM: excluding special items) increased 7.6%. Average fuel price (including taxes) increased 40.4% to $1.7 per gallon.

Increased costs are expected to hurt the bottom line of carriers in the second quarter too. United Continental expects unit costs in the second quarter to increase in the band of 4–5% on the back of higher labor costs. American Airlines’ announcement to hike wages of its pilots and flight attendants to match industry-leading levels are likely to limit its bottom-line growth further.

Other Headwinds

Apart from high costs, stocks in the airline space are being hurt by other issues like technical glitches and customer related issues. The passenger dragging incident at United Airlines, the wholly owned subsidiary of United Continental, on Apr 9, drew criticism from multiple quarters across the globe, resulting in multiple apologies from the company.

As possible fallout of the incident, United Airlines’ CEO Oscar Munoz is now no longer guaranteed to be the company’s chairman in 2018. Apart from United Continental, the likes of American Airlines and Spirit Airlines (SAVE - Free Report) also grabbed headlines due to unfavourable customer- related issues. Apart from the above, weather related issues like Winter storm Stella have hurt operations at carriers significantly, thereby laying them low.

The bearish Zacks Industry rank of 189 carried by the 25-member Zacks categorized Transportation-Airline industry also highlights the fact that airline stocks are undergoing tough times. The unfavorable rank places the industry in the bottom 26% of the 250+ groups enlisted.

Price Performance

The struggles of airline stocks can be further exemplified by the chart below, showing the share prices of key airline stocks lagging the Transportation-Airline industry over the last three months. While shares of Delta, American Airlines and Southwest Airlines (LUV - Free Report) have shed 4.3%,3.6% and 0.2% in the period, respectively, the United Continental stock has gained a mere 0.9% in the period. The industry, on the other hand, has gained 2.4% over the last three months.

Some tailwinds Remain

Although the current overall picture is rather gloomy in the airline space, the sector is not bereft of some positives, which includes the unit revenue scenario.

In the first quarter of 2017, some carriers like American Airlines displayed growth with respect to total revenue per available seat miles (TRASM). A few others aim to return to unit revenue growth during the course of the year. For example, Delta expects passenger unit revenue to increase in the band of 1% to 3% (on a year-over-year basis) in the second quarter. With rising oil rates, there exists the scope to raise ticket prices, thereby boosting revenues.

Moreover, the solid financial health of carriers has led to increased investments aimed at improving flying experience of passengers apart from hiking dividend payouts/buybacks along with profit sharing payments. Delta recently hiked its dividend payout by over 50% apart from clearing a fresh buyback plan.

How to Pick Winners?

The above commentary clearly reflects that despite headwinds all is not lost for airline stocks and there exists few hidden gems in the space for investors to unearth. The stocks have the potential to generate handsome returns.

However, given the vastness of the airline space and with most stocks struggling, it is by no means an easy task to identify the few bright spots. We have utilized our Zacks Stock Screener  to pinpoint such stocks. The Zacks Rank, which justifies a company’s strong fundamentals, can come in really handy.

Our Choices

Skywest Inc. (SKYW - Free Report) , headquartered at St. George, UT, operates as one of the major regional airlines in the U.S. SkyWest reported impressive numbers for the first-quarter 2017, comfortably beating the earnings and revenue estimates. The carrier holds a Zacks Rank #2 (Buy). The forward P/E ratio for the current financial year is 11.05. The 2017 Zacks Consensus Estimate has improved 3.6% to $3.16 per share over the last 30 days.

Deutsche Lufthansa Aktiengesellschaft operates as an aviation company in Germany and internationally. It operates through Passenger Airline Group, Logistics, MRO, and Catering segments. Deutsche Lufthansa has a Zacks Rank #2 and a Value Style Score  A. The forward P/E ratio for the current financial year is 9.55, which compares favorably to the S&P 500’s 18.3.

Ryanair Holdings plc (RYAAY - Free Report) is an Irish low-fare airliner that primarily operates from Europe. The carrier holds a Zacks Rank #2. It has a market cap of $23.9 billion and its shares have appreciated 18.2% over the last three months.

The 2017 Zacks Consensus Estimate has climbed 11 cents to $5.72 per share over the last sixty days.

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