It is a well-documented fact that woes related to capacity overexpansion had plagued stocks in the airline space for quite some time. In this context, we note that United Continental Holdings, Inc.’s (UAL - Free Report) shares had declined significantly in January 2018, even after reporting better-than-expected results in the fourth quarter due to its commentary related to capacity expansion.
United Continental carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
In such a scenario, investors fear that capacity expansion might lead to oversupply in the market even as oil prices are well below the highs touched in 2014. Low ticket prices in the United States also hint at the capacity overexpansion issue. While low air fares attract fliers, it dents profits for carriers.
February Traffic Reports Offer a Glimmer of Hope
Despite the above-mentioned headwinds, February traffic reports of most carriers seem to be encouraging, thus hinting at a decline in capacity-related woes in the airline space. This is because load factor (% of seats filled by passengers) has decreased at each of the above-mentioned carriers as traffic growth outweighed capacity expansion in the month.
At Delta Air Lines, Inc. (DAL - Free Report) , load factor improved 40 basis points year over year to 81.5% in February, with traffic increasing 3.8% and capacity expanding 3.4%. Higher traffic growth in the same month also led to 200 basis points, 340 basis points, 140 basis points and 190 basis points increase in load factor at Southwest Airlines Co. (LUV - Free Report) , GOL Linhas Aereas Inteligentes S.A. (GOL - Free Report) , United Continental and Hawaiian Holdings, Inc.’s (HA - Free Report) subsidiary — Hawaiian Airlines, respectively.
In fact, Southwest’s load factor expansion to 81% is a record figure for February.
Price Performance in February
In view of the favorable load factor readings, it is of little wonder that the Zacks Airline industry outperformed the broader market in February. While the S&P 500 Index gained 3.7%, the industry rallied 4.8%.
The impressive February traffic reports are likely to keep the long-standing capacity-related fears at bay, at least for now. Let’s take a look at some of the other factors which highlight the attractiveness of the sector.
Impressive Unit Revenue Projections
For the first quarter of 2018, unit revenue views are impressive, highlighting the solid demand for air travel. For example, American Airlines Group (AAL - Free Report) expects total revenue per available seat mile (TRASM: a key measure of unit revenue) growth between 2% and 4%. Meanwhile, United Continental envisions consolidated passenger unit revenue to be flat to up 2% year over year.
Delta anticipates total unit revenues (excluding refinery sales) to increase in the band of 2.5-4.5% (on a year-over-year basis) for the current quarter. In fact, the company expects to perform well on this front throughout 2018, with passenger unit revenue growth estimated in each quarter.
Dividends/Buybacks Bode Well
The likes of Alaska Air Group, Inc. (ALK - Free Report) and SkyWest, Inc. have already announced hikes in their respective dividend payouts in 2018. We expect other carriers to do the same in view of the new tax law (Tax Cuts and Jobs Act).
Notably, huge savings owing to the reduction in corporate tax rate implies that more cash will be available to fund their capital expenditures, acquisitions and share repurchases, among others. This bodes well for shareholders who will gain in the form of dividend hikes and more buybacks.
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