Airlines Are Hitting More Than Just an Air Pocket
iStock
The performance of airline stocks the last several months has been a vivid reminder of one piece of conventional Wall Street wisdom: Shares of air carriers are a trade. But they're not an investment.
Shares of the three leading network carriers -- Delta Airlines (DAL) - Get Report , United Continental Holdings (UAL) - Get Report and American Airlines (AAL) - Get Report -- all hit 52 week lows on June 27. In fact, in the cases of United and American, the pullbacks represented two-year lows. Any investors who felt emboldened to get into those stocks when the stocks were rallying to their highs in the first quarter of last year have lost 45% of that investment.
Here's where the notion of the trade comes in. Since those lows less than two weeks ago, airline stocks have bounced off their bottoms with United up 7%, Delta up 12% and American gaining 16%. Does that mean they're on a glide path back to sustained improvement? Not if the conventional wisdom holds.
Certainly, there's things to like about airlines. Fuel prices, the biggest input to airlines' cost structures, are still at a huge discount to where they were a couple years ago. Granted, those costs have gone up since January with crude prices effectively doubling from where they started the year. But they're still half the price they were in the summer of 2014 when airline stocks were last trading at these levels.
There's still those pesky fees and surcharges the industry succeeded in prevailing on customers during their distressed days, none of which they eliminated in their flush times.
Which isn't to say there haven't been some customer-friendly initiatives. Based on some new features, the flying experience has seemingly improved. Most of the network carriers have introduced ubiquitous seat-back entertainment systems and Wi-Fi access in steerage compartments -- the kind of amenities that used to only be available in business class. (Meanwhile, in the course of renovating those aircraft interiors, airlines found a way to slip a few more seats into economy cabins, usually by changing the dimensions of all those seats. Please return your tray tables to their position and your knees to your chin).
Regardless of how they treat customers, though, airlines turned downright cuddly toward investors. A year ago, Delta said it would return $6 billion to investors via buybacks and dividends. American has paid the first dividend the company has issued since 1980. United instituted a buyback plan.
But those shareholder-friendly initiatives haven't bought any long-term good will in the market. Partly it's the market's impression that companies ought to be socking some capital away during flush times so they have some resources to continue to treat shareholders well during the inevitable downturn. Airlines, instead, showed some of the capital discipline of sailors on the first night of shore leave after a long voyage. What's left when profits aren't as easy to come by?
And clearly, profits aren't going to be as easy to come by. The domestic economy is in the late stage of a long recovery (even if that recovery hasn't been as robust as economists would have liked). Airlines are late-stage companies. If airlines are going to trade in line with the broad market, as they've shown signs of doing lately, they're not going to react to any industry specific improvements, such as another pullback in crude prices.
Corporate profit growth has slowed, which has historically been a hurdle for airlines, and probably more so now than at any time in the past. Economy passengers are acutely price sensitive. They can log onto their computer and plumb for the cheapest seat available. That has meant that global air carriers, more than ever, have had to lean on their business travelers, who are less price sensitive and tend to pay something near full freight for their travel needs.
But historically as corporate profits slow, companies cut back on business travel. This environment for profit growth is probably a better time to invest in teleconferencing service providers than business-travel-dependent airlines. Revenues per available seat miles, a key industry metric, have already started to decline for some carriers.
All of which is exacerbated by the strength of the U.S. dollar, a factor Delta noted this week when it cut its forecast. The stronger dollar hits international passengers buying tickets for overseas departures. The rising dollar also inflates prices for commodities, such as crude oil.
Given the foreign exchange exposure, investors who are bent on investing in air carriers could likely do better to focus on domestic carriers, such as Southwest Airlines (LUV) - Get Report or Spirit Airlines (SAVE) - Get Report . Neither escapes the bite of higher fuel costs. But they are less dependent on business travelers, and are agnostic to any rise in the dollar. Proof that the market recognizes this: Unlike their network compatriots, neither has visited its lows for the year in months.
All of which is another way of saying that stocks of air carriers are not of the widows and orphans fund stripe. Rather than a long-term part of a solidly constructed portfolio, airlines are there for nimble investors to use as a trade.