Oil prices have been on the rise this year, shooting up more than 20% so far. Apart from the geopolitical tensions in the Middle East, the economic crisis in Venezuela — a major oil exporter — and OPEC’s recent plans of a lower-than-expected output raise have backed the rally in oil prices. Since fuel expenses are significant for airlines, an increase in oil prices is unfavorable for the space.
According to the recent commentary by Ed Bastian, CEO of Delta Air Lines, Inc. (DAL - Free Report) , the carrier is likely to incur additional costs to the tune of $2 billion in 2018 due to an increase in oil price.
In fact, it is not only Delta but the entire airline space that is likely to suffer due to a rise in fuel costs. In April, another airline heavyweight — American Airlines Group Inc. (AAL - Free Report) — had trimmed its current-year earnings per share projection due to high fuel costs.
Rise in fuel costs is likely to dent Delta’s profitability in the second quarter as well. This Atlanta, GA-based carrier slashed its second-quarter earnings per share guidance earlier this month, due to rising fuel costs. The metric is now likely to be in the range of $1.65-$1.75, much lower than the previous estimate between $1.80 and $2.
Apart from high fuel costs, woes related to capacity overexpansion have also been a thorn in the flesh for airline stocks. Highlighting the capacity-related woes, load factor (percentage of seats filled by passengers), which is an important indicator of profitability and efficiency for airline companies declined in May for major U.S. carriers, namely Delta and Southwest Airlines Co. (LUV - Free Report) . A fall in load factor indicates inefficient capacity utilization that creates more vacant seats.
Capacity expansion may lead to oversupply in the market even as fuel costs remain well below the highs of mid-2014, despite the recent resurgence. Moreover, airfares have remained low, with the metric declining in April as well as May. Low air fares are favorable for fliers but a drag on the top line of carriers due to their lesser profits.
Customer-related issues have been hurting airlines for quite some time. The unfortunate Apr 17 mid-air engine explosion on a Southwest Airlines Dallas-bound flight from New York resulted in the demise of one passenger and injured many.
Computer glitches are also hurting airline operations. American Airlines’ regional carrier PSA Airlines was the latest victim of such disruptions. In June, a computer failure at PSA Airlines adversely impacted its crew scheduling system. As a result of the disruption, the carrier’s operations were thrown haywire as it had to call off multiple flights. Needless to say, the cancellation of flights caused unwarranted harassments to its passengers.
Industry Underperformance in 1H
Judging by shareholder returns in the first half of the year, it seems that headwinds like high fuel and labor costs, capacity-related issues and technological glitches have contributed to investors’ pessimism surrounding the space.
The Zacks Airline industry, which is part of the broader Zacks Transportation Sector, has underperformed both the S&P 500 and its own sector year to date.
While the stocks in this industry have collectively lost 19.5%, the Zacks Transportation Sector has shed 7% of its value. Meanwhile, the Zacks S&P 500 Composite has rallied 1.9% in the first half of the year.
1H Price Performance
Zacks Industry Rank Highlights the Struggles
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates continued underperformance in the near term.
The Zacks Airline industry currently carries a Zacks Industry Rank #230, which places it at the bottom 10% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Our proprietary Heat Map shows that the industry’s rank has been bearish over the past five weeks.
What’s in Store in 2H?
The bearish forecast by the International Air Transport Association (“IATA”) on current-year airlines’ profitability highlights the fact that the woes are likely to continue for carriers. The research firm predicts global net profit for the industry to be $33.8 billion, much lower than the 2018 profitability forecast of $38.4 billion, unveiled in December 2017.
Global net profit margin is expected to contract to 4.1% in 2018 from 5% a year ago. The firm projects that jet fuel prices are likely to escalate around 27.5% to $70 per barrel this year. The fuel bill is likely to account for 24.2% of total costs in 2018 (21.4% in 2017). Escalating oil prices apart, labor and interest costs also weighed on the profitability forecast.
Dump These Carriers from Your Portfolio Now
In view of the above challenges confronting the space, we have zeroed in four carriers that investors would do well to get rid of from their respective portfolios as chances of favorable returns in the near term appear bleak. This is because, similar to wise buying decisions, exiting certain underperformers at the right time helps maximize portfolio returns.
All the stocks have an unfavorable Zacks Rank and have witnessed negative earnings estimate revisions recently.
(You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here).
JetBlue Airways Corporation (JBLU - Free Report) is a low-cost carrier based in Long Island City, New York. The company carries a Zacks Rank #4 (Sell). The stock has seen the Zacks Consensus Estimate for current-quarter earnings being revised 2.4% downward in the last 60 days. The JetBlue stock has shed 15% of its value in the first half of the year.
Based in Las Vegas, Allegiant Travel Company (ALGT - Free Report) is the parent company of Allegiant Air. The company, carrying a Zacks Rank #4, offers air travel both on a stand-alone basis and bundled with hotel rooms, rental cars and other travel-related services. The stock has seen the Zacks Consensus Estimate for current-quarter earnings being revised 1.8% downward in the last 60 days and has shed 10.2% of its value in the first half of the year.
Ryanair Holdings plc (RYAAY - Free Report) is an Irish low-cost carrier carrying a Zacks Rank #5 (Strong Sell). The stock has seen the Zacks Consensus Estimate for current-quarter earnings being revised 7.4% downward in the last 60 days and has shed 6.4% of its value in the last three months.
Azul SA (AZUL - Free Report) is the largest airline in Brazil in terms of the number of cities served. The Zacks Consensus Estimate of loss for the current-quarter has widened significantly at Azul over the last 60 days. Additionally, the stock, carrying a Zacks Rank #4, has seen the Zacks Consensus Estimate for current-year earnings being revised 38.3% downward in the last 60 days and has shed 31.3% of its value in the first half of the year.
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