The global aviation industry offers an optimistic outlook for
the rest of 2014 as an expanding economy and rising cargo and
passenger traffic drive demand. Rise in passenger travel demand,
particularly in North America, Middle East and Asia Pacific, plus
accelerated replacement of obsolete aircraft will likely boost the
industry's overall performance.
According to the International Air Transport Association (IATA),
the expansion of the economic cycle along with rapid GDP and world
trade growth is expected to boost air travel by 5.9% − the best
since 2011. The rise in capacity may, in turn, lead to a 3.5% cut
in airfares, thus benefiting travelers.
The IATA remains cautiously positive on the industry and projects
overall airline profits of $18.0 billion on revenues of $746
billion for 2014, from an estimated 3.32 billion passengers. In
2014, net profit margin is expected at 2.4%, up from 1.5% in 2013.
The industry is expected to generate $5.42 from every departing
passenger on an average, a rather soft number for a high-risk
Additionally, air cargo volumes -- an important indicator of
business confidence -- have been in a troubled spot since 2010.
However, figures have been recovering since the start of 2014 and
could expand 3.1% in the course of the year to reach $197 billion.
Nonetheless, the bullish stance may be partially impeded by the
negative vibes surrounding air travel following the recent Malaysia
Airlines catastrophe and an upturn in jet fuel prices. Apart from
geo-political tensions in Eastern Europe and the Middle East, an
alarming increase in the number of airborne plane crashes raises
With the world's largest economy improving, airlines in North
America hold bright prospects in 2014. Consolidation benefits,
rising travel demands and several new and enhanced ancillary
revenues provide an impetus to growth. Although performance will
continue to vary substantially between different U.S. carriers, a
strong 2013 has made way for a higher 2014 profit forecast of $9.2
Carriers in this region are expected to post profits of $3.2
billion in 2014, higher than $2.0 billion recorded in 2013, based
on strong cargo demand and healthy passenger travel demand.
Europe, which continues to recover slowly within the home front,
will tend to be affected by stiff competition and high regulatory
costs. Thus, despite having the second best load factor, the IATA
expects this year's post-tax profit for European carriers to reach
Per the IATA, profits from carriers in the Middle East are expected
to grow from $1.0 billion in 2013 to $1.6 billion in 2014 driven by
rapid growth of airlines in the Gulf. Regional co-operation and
international partnerships should further add to the success of
The region's profitability is expected to enhance substantially
from $200 million in 2013 to $1.1 billion in 2014. Weaker
performance in the home market is expected to be offset by success
in some long-haul markets and consolidation benefits.
Airlines in the African continent could see their profits touching
the $100 million mark, rebounding from a loss of $100 million in
2013. Although performance is improving slowly, Africa remains the
weakest region, owing to low developmental opportunity for
inter-Africa connectivity, high infrastructure cost and taxation.
Emergence of Middle East Carriers
As U.S. passenger carriers are still trying to recover from the
domestic economic sluggishness, several Gulf-based airlines have
come to the forefront, fortifying their positions within the global
airline industry. Emirates leads the pack, followed by Etihad and
Qatar Airways, expanding in Europe, Africa and the BRICS, thus
laying the foundation for an overall successful aviation sector.
Recently, Emirates stood true to its commitment made last year by
announcing a $56 billion order to buy 150 777x jets from The Boeing
), with an optional plan to buy 50 additional aircraft. Emergence
of these cash-rich airline companies remains a concern for the
legacy carriers, including those in the U.S., which might lose a
chunk of their international market as most passengers continue to
move through the Gulf.
India - A Golden Opportunity
The aircraft manufacturing giant Airbus and Boeing have both raised
their 20-year outlook on India, owing to the high appetite for
growth but low market penetration of airline services in the
country. Further, India's large demography supports the growth of
air transportation service as the country's working population
continues to rise. The optimism swelled after Boeing received
orders for 42 B-737 aircraft from SpiceJet worth $4.4 billion,
while Tata Group's twin airline joint ventures with Singapore
Airlines and Air Asia Berhad have opted for Airbus' A-320 fleet.
Brazilian vendor Embraer SA (
) also got a $2.5 billion order from Indian regional airline Air
According to Boeing, Indian carriers will buy 1,600 aircraft worth
$205 billion between 2013 and 2032, while its counterpart Airbus
expects India to place orders for 1,290 planes valued at $190
billion. The aircraft manufacturing duo has predicted that a
significant part of the order will constitute single-isled narrow
bodied aircraft like Airbus A320 or Boeing 737s. The country
recently got its latest passenger carrier in the form of Air Asia
India, which aims to reduce costs and eventually transfer them into
The long-term rosy picture is, however, partially offset by the
short-term weakness within India's aviation industry, which
continues to suffer from over capacity. Additionally, airfares have
also surged in the last five years resulting in lower demand for
Underlying Factors for 2014 Profits
In the base-case scenario, there are several dynamics that will act
as driving factors for overall airline profits in 2014. These
Passenger & Cargo:
The IATA suggests that economic recovery coupled with faster GDP
and world trade growth will drive air transportation demand.
Customers on the other hand will benefit from cheaper air travel as
one-way fares are expected to reduce 3.5% this year. The
association projects global airline passenger growth of 5.9%. The
average industry load factor is expected at 80.4%.
Coming to demand-supply balances, demand (measured in traffic) is
expected to outpace capacity in 2014. While the projected capacity
increase is 5.5%, air travel demand is expected to see a 5.9%
Fuel Price Effect:
Airline profit outlook depends largely on fuel prices, the major
variable component in the industry. For 2014, average jet fuel
prices are expected to stay at $124.2 per barrel, a notch lower
than the $124.5 per barrel cost in 2013. Lower jet fuel price
drives airline profits by reducing operating expenses. However, the
political crisis in Middle East has led to upward pressure on
. The association projects fuel cost of $212 billion in 2014,
accounting for almost 30% of the overall operating cost.
Air carriers at large are looking for fuel efficient fleets in
order to reduce their cost burden that has increased 55% over the
period 2006-2013. The carriers are concentrating more on making
money rather than expanding its market share. The companies
continue to replace old and depleted airplanes with new and
upgraded ones. Escalating oil prices have also played a major part
in the fleet replacement decision.
According to Boeing, over the next 20 years, global airlines are
expected to invest around $5.2 trillion in fleet development. Over
the long run, the carriers aim to replace their old narrow-body
jets -- A320's/B757-200/300 -- with advanced narrow-body airplanes
such as A-321, A320 Neo and the B737 Max, for better service and
With passengers demanding comfort and quality service along with
proper security, airlines are focusing on aircraft redesigning with
new and attractive products and services within the travel plan.
United Continental Holdings Inc. (
) is offering premium flat-bed cabin seats on every long-haul
Further, the carrier has installed in-seat power on more than
half of its mainline fliers and has paced up the installation of
the satellite-based first ever Wi-Fi service for fliers. Delta
Airlines Inc. (
) also plans to invest $750 million over the next two-year period
to roll out Wi-Fi as well as renovate the interiors of its
narrow-bodied aircraft over the next three years.
Hedging strategies are frequently used by airline companies to cope
with the rising fuel prices. The carriers use a combination of
calls, swaps and collars at varying WTI crude-equivalent price
levels to hedge.
Zacks Industry Rank
Within the Zacks Industry classification, airlines are broadly
grouped into the Transportation sector (one of the 16 Zacks
We rank all the 260-plus industries in the 16 Zacks sectors based
on the earnings outlook and fundamental strength of the constituent
companies in each industry. To learn more visit:
About Zacks Industry Rank
As a point of reference, the outlook for industries in the top
one-third of the list (with Zacks Industry Rank #88 and lower) is
'Positive,' the mid one-third of the list (between #89 and 176) is
'Neutral,' while the last one-third (#177 and above) is 'Negative.'
The Zacks Industry Rank for the airline industry is currently #31,
implying that the outlook remains positive on this sector for this
year owing to a rise in passenger air travel demand.
The broader Transportation sector, of which aviation is a part,
reflects a stable growth pattern. So far, 91% of the sector
participants in the S&P 500 index that combined account for
97.7% of the sector's total market capitalization have reported
second quarter results, which have been fairly good in terms of
growth rates and beat ratios.
Total earnings for these companies are up 11.7% on 6.7% higher
revenues, with 90% of the companies beating EPS estimates and 80%
coming ahead of revenue expectations. This is better performance
than we have seen from the Transportation sector in other recent
The Consensus earnings expectation is pegged at 6.8% for the third
quarter and 13.2% for 2014. The fourth quarter is expected to
register earnings growth of 13.8%. The revenue growth expectation
is pegged at 5.2% for the third and the fourth quarter, as well as
for full-year 2014.
For more details about earnings for this sector and others, please
read our '
We believe industry consolidation and various ancillary revenues
will boost the profitability and cost performance of most air
carriers going forward. This is a suitable time for companies to
consolidate for higher profits and operational efficiency.
Additional Revenue Gains:
Air carriers are increasingly focusing on passenger satisfaction
and experience to drive growth. JetBlue Airways Corp. (
) augmented its TrueBlue loyalty program by allowing a single
customer to earn and use points as a group, while Delta has
upgraded its Economy Comfort seating in all transcontinental
flights operating from New York's JF Kennedy Airport to Los
Angeles, San Francisco and Seattle. The IATA projects total revenue
of $746 billion in 2014.
Mergers & Acquisitions:
Airline companies unite in order to restore lost profits and
broaden their perimeter. This was evident in the past mega mergers
within the industry involving Northwest Airlines and Delta Air
Lines in 2008, United Airlines and Continental Airlines in 2010 and
AirTran Holdings and Southwest Airlines Co. (
) in 2011. All three companies -- Delta, United and Southwest --
are long-term beneficiaries on capacity and cost fronts.
The recently merged U.S. Airways Group Inc. and AMR Corporation
have gained in size and capacity by creating the largest global
carrier American Airlines Group Inc. (
). Despite the merged entity having more pricing power and control
over a larger number of slots, we believe it will have little
effect on the dynamics of the U.S. aviation industry as 80% of the
same market will be dominated by the new American Airlines, United
Airlines, Delta and Southwest Airlines.
North American carriers are continuously striving to increase their
range of domestic and international flights. United Airlines is
planning an international service between Los Angeles and Melbourne
from Oct 2014. To expand operations in Latin and Central America,
United Airlines plans to introduce services to Chile, Dominican
Republic and Belize from Dec 2014. Some U.S. carriers are also
forming joint ventures with foreign partners to offer better
connectivity to their customers.
Delta Airlines is strengthening its position in Seattle by adding
several domestic and international destinations from the western
coastal city in addition to reinstating its Barbados operation
after a gap of 3 years. Likewise, after operating for several
decades within the U.S. domestic market, Southwest Airlines is
finally flying into international territory, with flights to the
Caribbean. The carrier recently inaugurated services from Atlanta,
Baltimore and Orlando to Oranjestad, Aruba and Montego Bay,
Jamaica. Route expansion coupled with affordable ticket pricing
will augment passenger travel demand.
The formation of American Airlines has opened up new opportunities
for Southwest Airlines, JetBlue and Virgin America as the merged
entity has divested take-off and landing slots at Washington's
Reagan National Airport (DCA) and New York's LaGuardia Airport
(LGA). Further, American Airlines is currently in the process of
divesting gates and related facilities at each of the Boston,
Chicago, Dallas, Los Angeles and Miami airports.
Air carriers are opting for numerous technology upgrades and system
automation for various activities such as airline reservation,
flight operations and website maintenance. These upgrades allow the
companies to function effectively and efficiently, minimize
expenses and render better customer service.
The latest is the installation of the Automated Passport Control
(APC) kiosks, which will allow U.S. bound international passengers
to enjoy a faster and smoother passport clearance process. Mobile
boarding pass is another new technological advancement that allows
passengers to use their smart mobile devices to get through
security check points and board their flights sans any
inconvenience or delay.
Emergence of Smaller Carriers
Although consolidation within the U.S. aviation industry will
reduce competition, it is expected to be short lived because of the
low barriers to entry within the same. Further, the rising profit
margins within the industry have allowed the smaller operators to
expand. The most aggressive of these are Spirit Airlines Inc. (
), which plans to double its fleet size by 2017.
PeopleExpress is the latest addition in this list as the
Virginia-based start-up plans to expand its services in 24 cities
within the next 5 years. These ultra-low fare carriers are gaining
popularity by providing low cost options for domestic travelers,
thus gaining popularity among low end customers.
The major outperformers should be American Airlines, Delta and
Southwest Airlines all with a Zacks Rank #1 (Strong Buy). We also
uphold Zacks Rank #2 (Buy) stocks such as JetBlue Airways,
Allegiant Travel Company (
) and Alaska Airlines Group Inc. (
). Copa Holdings SA (
) and GOL Linhas A (
) currently hold a Zacks Rank #3 (Hold).
Of the many challenges facing the industry, the most crucial ones
include slow economic recovery, volatile fuel prices, natural
calamities, industry consolidation, government regulation,
unionization, airport infrastructure constraints, technological
investments and safety concerns.
Pitfalls of Industry Consolidation:
Over the last few years, the U.S. aviation industry has seen
several consolidations with the most significant one being U.S.
Airways with American Airlines in 2013. With major and legacy
airlines of the U.S. joining forces, the total number of carriers
operating within the industry is becoming less. This has resulted
in less competition, higher airfares and increased fees, thus
affecting the fliers.
Lack of qualified pilot is disrupting airline operation
particularly for the smaller carriers in some parts of U.S. thus
forcing them to keep their aircrafts grounded. The Federal Aviation
Administration's (FAA) rule of minimum 1,500 hour of flying
experience is been held as the root cause for the shortfall of
Oil Price Volatility:
Fuel price volatility continues to be one of the significant
challenges, as fuel costs are largely unpredictable. The
geopolitical unrest will continue to affect crude oil prices.
Airline carriers' ability to pass along the increased costs of fuel
to its fliers is restricted by the competitive nature of the
The airline business is labor intensive. Most of the employees are
unionized and depend on various U.S. labor organizations. The
relation between airlines and labor unions are governed by the
Railway Labor Act, which states that a collective bargaining
agreement between an airline and a labor union does not expire --
instead it becomes amendable as of a stated date. Failure to amend
terms and conditions suitably may lead to work stoppages or
strikes, and thereby hamper operations.
Similarly, the airline industry in the rest of the world is also
exposed to labor related concerns -- proved by the ongoing
pension-related dispute of Aer Lingus and its largest trade union,
which led to the former reluctantly agreeing to pump in additional
fund to revamp its superannuation scheme.
The airline industry is highly regulated, in particular by the
federal government. All companies engaged in air transportation in
the U.S. are subject to the regulations implemented by the
Department of Transportation (DoT). Further, airlines are also
regulated by FAA, a division of the DoT, primarily in areas of
flight operations, maintenance and other safety and technical
matters. The new stringent pilot duty and rest rules under FAR117
will increase the carriers' expenses as the companies will need to
hire more pilots to comply with the stated rules.
Technological investment is a key expense for air carriers. The
profitability of airlines could be affected by technology glitches
or failure to invest in new technologies.
We expect Latam Airlines Group SA (
) and Bristow Group Inc. (
), to underperform the broader market. Both the stocks currently
hold a Zack Rank #4 (Sell).
Want the latest recommendations from Zacks Investment Research?
Today, you can download 7 Best Stocks for the Next 30 Days.
Click to get this free report
UNITED CONT HLD (UAL): Free Stock Analysis
SPIRIT AIRLINES (SAVE): Free Stock Analysis
SOUTHWEST AIR (LUV): Free Stock Analysis Report
LATAM AIRLINES (LFL): Free Stock Analysis
JETBLUE AIRWAYS (JBLU): Free Stock Analysis
GOL LINHAS-ADR (GOL): Free Stock Analysis
EMBRAER AIR-ADR (ERJ): Free Stock Analysis
DELTA AIR LINES (DAL): Free Stock Analysis
COPA HLDGS SA-A (CPA): Free Stock Analysis
BRISTOW GROUP (BRS): Free Stock Analysis Report
BOEING CO (BA): Free Stock Analysis Report
ALASKA AIR GRP (ALK): Free Stock Analysis
ALLEGIANT TRAVL (ALGT): Free Stock Analysis
AMER AIRLINES (AAL): Free Stock Analysis Report
To read this article on Zacks.com click here.