Declining fuel prices have been a blessing in disguise for the airline industry for quite some time now. However, oil recently faced a heavy blow, spiraling down to a 13-year low of $27 per barrel in February, this year. This reflects a significant decline from the approximate $105 per barrel recorded in Jul 2014.
Lackluster global demand coupled with a glut in supply has resulted in the massive slide in the price of the commodity. Earlier this week, crude fell 3.4% to $37.18 a barrel following soft economic data issued by China and speculations over Iran’s oil production plans.
A strong correlation exists between the decline in crude prices and airline stocks as fuel forms the major cost component of airline companies, accounting for nearly 30% of the total operating expenses. Thus, a dip in oil prices triggers a rise in the bottom line of the airline industry.
As per data released by the International Air Transport Association (IATA), the overall airline industry is expected to generate $36.3 billion in net profits in 2016, signifying a profit margin of 5.1% buoyed by lower fuel prices and increased travel demand. IATA also believes that North America will continue to dominate more than half of the aviation industry with expected profits of nearly $19.2 billion in 2016.
In the recently concluded fourth quarter of 2015, U.S. legacy carriers American Airlines (AAL – Analyst Report), Delta Air Lines (DAL – Analyst Report) and United Continental Holdings’ (UAL – Analyst Report) subsidiary United Airlines witnessed a strong year-over-year upside in the bottom line.
With oil prices expected to remain weak in the near term, carriers are likely to generate huge savings as is evident from Delta Air Lines’ projected savings of over $3 billion in 2016.
Apart from boosting the bottom line, cheap oil has led to a surge in buybacks and dividend payouts, increased investments by carriers to enhance the flying experience for travelers and higher profit sharing payouts.
However, increasing airline capacity, a strong U.S. dollar and lower fares will continue to undermine passenger revenue per available seat mile (PRASM) growth for the airline industry. In the recently concluded fourth quarter of 2015, most airline companies projected a decline in PRASM for the first quarter of 2016.
United Airlines expects PRASM (on a consolidated basis) in the first quarter of 2016 to decline 6% to 8% while Delta Air Lines anticipates a drop in PRASM in the band of 2.5% to 4.5% for the same period.
Despite the aforementioned issues, the slump in oil price continues to make this sector an attractive bet. The Zacks Industry Rank #22 sported by the “Trans-Airline” segment comfortably places it at the top 1/3rd of the 260+ member industry group and justifies our bullish stance on the sector, despite some hiccups.
