Why Airfares Aren't Likely to Decline Despite Falling Fuel Prices

NEW YORK( TheStreet) -- Falling fuel prices are  a huge boon for the airline industry, which is headed for one of its most profitable years ever. But don't expect fliers to get a share of the benefits. 

Scarred by the traditional ups and downs of the industry, airlines are avoiding not only cutting airfares but also increasing capacity, which can stimulate even more profits given the reduced cost of flying.

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No carrier has even hinted at cutting fares. In fact, most raised round-trip domestic fares by about $4 in mid-October. Wall Street, meanwhile, has been outspoken in its opposition to adding capacity.

"Fiscal responsibility and customer investment are the themes that are driving the industry now," John Heimlich, economist for Airlines for America, the industry's trade group, told reporters Thursday in response to a question about airfares.

"The first priority is to make sure you have strong financial health," Heimlich added. "We are much more vulnerable to recessions and cyclicality than other industries are. We don't hear people clamoring for lower prices of cheeseburgers when beef prices come down or for lower prices of iPhones when semiconductor prices go down."

Instead of cutting fares, Heimlich indicated, airlines are investing in new aircraft, with an estimated 317 deliveries in 2014; new ground equipment; improved airport facilities; as well as Wi-Fi and new technology, including improved computers. Capital expenditures for the top nine airlines totaled $12.4 billion in 2013 and $10.2 billion in the first three quarters of 2014.

"It's not in the employees' or customers' interest not to put that money back to work for the customer," Heimlich said.

In October, during American Airlines' (AAL) third-quarter earnings conference call, President Scott Kirby was asked about the likelihood of a fare price cut as a result of falling oil prices. The answer: not very likely.

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"Airfares remain a great bargain and fares are very low -- down significantly in real terms in the last 20 to 30 years, down significantly as a percentage of GDP in the United States," Kirby said. "And a great bargain compared to almost any other good that you consider.

"When I get on a flight and go to New York I think half the people on the airplane pay less for the round-trip ticket than I pay for my hotel room when I get to New York," he said. "So air travel remains a great bargain and we will continue to keep it a great bargain for customers, but in a strong demand environment, we don't have plans to go off and just proactively cut fares."

Meanwhile, some analysts have expressed fears of "capacity creep," which they believe could result from over-enthusiastic airlines adding new flights as a result of lower fuel prices.

Wolfe Research analyst Hunter Keay recently downgraded the entire sector to market weight from market overweight. The current industry mantra -- that capacity should grow at a rate that's in line or below the country's gross domestic product -- "represents a threshold of what's acceptable," Keay wrote.

"If the goal is to maximize profits on lower input costs (uncontrollable costs, by the way) we'd prefer to see it come from higher prices rather than from more supply," he said, adding that he is particularly concerned about recently unveiled projections for 2015 domestic capacity growth.

Speaking Thursday at an investor conference, Jim Compton, United's (UAL) chief revenue officer, said the carrier intends to increase capacity at a rate below GDP. In 2014, he said, capacity will grow 0.2% to 0.4%, while GDP growth will be around 2%. In 2015, United's capacity growth will be 1.5% to 2%, with domestic growth between 0.5% and 1.5%, also below projected GDP rates. "Watching GDP, we think we are well positioned with our capacity growth," Compton said.

In a recent report, CRT Capital analyst Mike Derchin said he reviewed projected airline schedules for the next six months and "found no evidence of capacity creep.

"Domestic capacity growth of 3% appears in line with GDP forecasts," Derchin wrote. He said system capacity growth is also 3%, reflecting a decrease of 1.5% across the Atlantic. Growth in Latin America and the Pacific is higher, but the regions account for smaller shares of industry capacity. Derchin has buy ratings on all nine major airlines.

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 Written by Ted Reed in Charlotte, N.C.

To contact this writer, click here.

Follow @tedreednc

At the time of publication, the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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