US Airlines to Remain Profitable - Analyst Blog

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The U.S. airline industry is expected to remain profitable over the next two decades given the increasing worldwide trends in air travel. However, growth would be held back until 2015 due to surging fuel costs and economic uncertainties in the U.S. and Europe.

Travel to Spur Air Traffic Growth

Although U.S. airlines will see a small dip this year, the demand for air travel would double over the next 20 years, as predicted by the U.S. Federal Aviation Administration ( FAA ).

Passenger demand is expected to remain stable or increase slightly this year to 732 million. Thereafter, it would grow 2% to 746 million in 2013 and about 3% in future years reaching $1 billion by 2024 and $1.2 billion by 2032.

The FAA projects air traffic, customarily measured in billions of revenue passenger miles, implying one mile flown by one passenger, to grow by more than 90% over the same period. Revenue passenger miles would jump from 815 billion reported last year to 1.57 trillion by 2032 at an average annual rate of 3.2%.

International traffic is expected to grow wider than domestic travel bounding 4.2% per year while the latter will rise at a more modest clip of 2.7% annually through 2032. This projection assumes a steady economic recovery with no major calamities like a large rise in oil price, swings in macroeconomic policy or financial meltdowns.

Further, major North American airlines such as United Continental Holdings Inc. ( UAL ), Delta Air Lines ( DAL ), Southwest Airlines Co. ( LUV ), JetBlue Airways Corporation ( JBLU ) and US Airways Group Inc. ( LCC ) would raise capacity (available seat miles) at an annual rate of 3.1% reaching 1.89 trillion by 2032.

Underlying Growth Factors

The 20-year airline growth is expected to stem from the implementation of NextGen, the satellite-based navigation system that aims to make air travel more efficient. Further, the carriers are taking numerous steps to improve their profitability. Fare hikes and fuel hedging are the most effective tools to counter the negative impact from rising fuel prices. Hedging strategies provide a cushion to fuel price volatility and are used extensively by the majority of air carriers.

The companies' ability to pass along the increased costs of fuel to their customers is nonetheless limited by the competitive nature of the airline industry. However, the carriers have been successful till now in passing along the higher prices to customers in the form of fare hikes. Last month, Southwest, JetBlue, United, Delta, American and US Airways have all raised ticket prices on many flights by $10 per round trip. Last year, the airlines have implemented about 10-12 fare hikes. The trend, it appears, will continue throughout the decade albeit at a slower pace, as crude oil price is projected to approach $140 per barrel by 2032, according to the FAA.

Additionally, the growing demand for air travel and a relatively lesser number of planes will make future fare hikes possible over the next two decades. Besides, airline mergers and consolidation will bring down the number of flights and reduce the number of cities served.

Our Take

To sum up, increasing demand for global air travel and a concomitant rise in fares justify our optimistic thesis on the airline industry as a whole. Further, air carriers are cutting capacities and adding novel features to their services, as well as introducing new products. These measures will fuel revenue growth and reduce non-fuel costs thereby driving future profitability.

Moreover, the carriers are focusing on fleet rightsizing. Though initially expensive, this seems to be the correct strategy to lower non-fuel costs. Air carriers are replacing their older fleet, which are no longer practical in a fuel-expensive environment, with the latest fuel-efficient aircrafts.

We maintain our long-term Neutral recommendation on Delta, United Continental, Southwest and JetBlue. For the short term (1-3 months), JetBlue retains a Zacks # 2 (Buy) Rank while the rest hold the Zacks # 3 (Hold) Rank.

DELTA AIR LINES ( DAL ): Free Stock Analysis Report
JETBLUE AIRWAYS ( JBLU ): Free Stock Analysis Report
US AIRWAYS GRP ( LCC ): Free Stock Analysis Report
SOUTHWEST AIR ( LUV ): Free Stock Analysis Report
UNITED CONT HLD (UAL): Free Stock Analysis Report
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

This article appears in: Investing , Business , Stocks
Referenced Symbols: DAL , FAA , JBLU , LCC , LUV

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