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Here's Why Airlines Spread Wide Wings in Friday's Trading

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Airline stocks have been laid low this year, mainly due to concerns about rising fuel costs. However, this headwind was put on the back burner last Friday as oil prices declined, resulting in airlines experiencing a field day.

It is a well-documented fact that the health of airline stocks is inversely related to oil prices. This is because fuel costs denote one of the most significant expenses for carriers. Consequently, the fall in oil prices leads to a significant decrease in the airlines’ operating expenses, thereby aiding the stocks’ bottom-line growth.

On May 25, oil prices decreased significantly to around $67.88 per barrel following reports that OPEC and Russia were discussing an increase in oil production.  In fact, oil prices had been on the downside over the past four days, thanks to the above issue.

Airlines Lead Dow Transports' Rally on Friday

The Dow Jones Transportation Average — a price-weighted average of 20 U.S. transportation securities — ended the May 25 trading session at 10,900.06, up 0.4%.  The index includes railroads, truckers, marine transportation, delivery services and logistics companies apart from airlines. Hence, the Dow Jones Transportation Average Index can easily be deemed the true representative of U.S. transportation division.

The Dow Jones Transportation Average Index includes six airline stocks, namely Delta Air Lines, Inc. (DAL - Free Report) , United Continental Holdings, Inc. (UAL - Free Report) , American Airlines Group Inc. (AAL - Free Report) , JetBlue Airways Corporation (JBLU - Free Report) , Alaska Air Group, Inc. (ALK - Free Report)      and Southwest Airlines Co. (LUV - Free Report) .

The fact that airlines heaved a sigh of relief on May 25 is evident from the index’s top six gainers being airline stocks with shares of the Zacks Rank #3 (Hold) Alaska Air Group registering the maximum rise of 3.3%. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The above impressive performance resulted in the NYSE ARCA Airline Index gaining 2.3% to close Friday’s trading session at $108.81. Additionally, the 34-member U.S. Global Jets ETF (JETS - Free Report) , which provide exposure to the global airline industry, grew nearly 2% on May 25, ending the day at $31.19.

Oil Price Plunge Follows A4A’s Bullish Summer Travel Projection  

The drop in one of the largest input costs for airlines could not have come at a better time for sector participants. This is because the summer travel season is round the corner and marks the busiest time for airlines.

According to Airlines for America (‘A4A’) — the largest airline trade association in the United States — the upcoming summer season (Jun 1-Aug 31) is expected to be the most hectic period for U.S. carriers in terms of air travel. Per the forecast, approximately 246.1 million passengers (2.68 million flyers daily) will be transported by U.S. airlines this summer, up 3.7% year over year.

In fact, to meet the surge in travel demand, the U.S. carriers are increasing the number of available seats by 116,000 each day. Also, with the U.S. economy improving and consumer confidence remaining strong, more Americans are taking vacations. Moreover, a much-improved job market and rising disposable income have added an incentive for consumers to opt for air travel.

Driven by the above tailwinds, the three-month phase is likely to see 96,000 additional passengers taking to the skies each day on various U.S. carriers.

With the upbeat guidance already in place, the waning oil prices provide further good news to airlines. No wonder, airline stocks concluded the previous week on a high.

Valuation Signals More Upside

The attractive valuation for the Zacks Airline industry suggests that the rally on May 25 is not a one-off phenomenon and that stocks in the space remain attractive investment bets. Going by the EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation and amortization) ratio —often used to value airline stocks — given their significant debt levels, and high depreciation and amortization expenses, the industry does not look expensive at this point.

The industry currently has a trailing 12-month EV/EBITDA ratio of 6.3 (near the lowest point of 5.8 in a year’s time), comparing favorably with the market at large as the current EV/EBITDA ratio for the S&P 500 stands at 11.3. The industry’s favorable positioning compared with the overall market certainly hints at more upside.

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