Although fuel costs have been increasing, air fares in the United States declined in April according to data released by the Bureau of Labor Statistics. Per the report, ticket prices decreased 2.7% on a month-on-month basis, making it the sharpest fall in four years.
Moreover, in April, average air fares (unadjusted) fell 6.9% from the comparable figure a year ago. Notably, the April reading comes after two successive months of increase in airfares. Even though, low air fares spell good news for fliers, it is likely to hurt the top line of airline companies.
Excessive Competition Pressurize Air Fares
The decline in airfares has been attributed to the intense competition in key markets. In fact, the low-cost carrier, Southwest Airlines Co. LUV , had cited the competitive fare scenario as a reason for its disappointing first-quarter unit revenues.
Moreover, the significant growth of low-cost carriers like Spirit Airlines, Inc. SAVE and Southwest Airlines has not gone unnoticed by legacy carriers including American Airlines Group Inc. AAL and United Continental Holdings, Inc. UAL . Both these companies carry a Zacks Rank #3 (Hold). You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here .
In a bid to combat the threat of low-cost carriers and attract budget-conscious travelers, both the above-mentioned legacy carriers have been selling cheaper tickets (Basic Economy Fares) for quite some time. In a price-conscious economy, it is not just the survival of the fittest, but of the cheapest. Keeping this in mind, big airline players are now looking to attract budget-friendly travelers.
Capacity overexpansion may lead to oversupply in the market and is one of the significant factors behind suppressed air fares. Fears that airline capacity would grow at a rate higher than the U.S. GDP, thereby resulting in an oversupplied market, have been one of the main challenges in the airline space.
Moreover, the April traffic reports of most carriers, including the likes of Delta Air Lines, Inc. DAL , Southwest Airlines, United Continental and Hawaiian Airlines, the subsidiary of Hawaiian Holdings, Inc. HA , have revealed that capacity expanded at a higher pace than traffic. Consequently, load factor (percentage of seats filled by passengers) declined in the month at the above-mentioned carriers.
Airfares to Increase in Future?
Despite the significant decline in April airfares, we expect ticket prices to go up in the coming months. The obvious reason is the upsurge in expenses on fuel. Oil prices had increased 5.6% in April. U.S. President Donald Trump's decision to withdraw from a nuclear deal with OPEC-member Iran has further boosted oil prices .
Currently, oil prices are hovering at around $71 a barrel. It is a well-documented fact that the health of airline stocks is inversely related to oil prices. This is because fuel costs represent one of the most significant expenses for carriers. Evidently, the rise in oil prices induces significant increase in operating expenses of carriers, thus limiting bottom-line growth.
In fact, the first-quarter earnings season, which is over for airlines, witnessed many stocks in the space suffering due to rise in fuel costs. Notably, oil prices were up approximately 8% in the January-to-March period.
In a bid to counter the challenges posed by surging oil prices, airlines are likely to increase air fares. Also, American Airlines' CEO, Doug Parker, has hinted at higher ticket prices.
Given the present scenario related to the increase in one of the largest input costs of airlines, we believe that the drop in April ticket prices is an isolated event. In the coming months, air travel in the country is expected to get more expensive as airlines look to pass on the increased costs to consumers, so that their profits are not dented.Whatever be the actual outcome, we anticipate investor focus to remain on this burning issue of air ticket prices, going forward.
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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 Southwest Airlines Co. (LUV): Free Stock Analysis Report Delta Air Lines, Inc. (DAL): Free Stock Analysis Report United Continental Holdings, Inc. (UAL): Free Stock Analysis Report Spirit Airlines, Inc. (SAVE): Free Stock Analysis Report Hawaiian Holdings, Inc. (HA): Free Stock Analysis Report American Airlines Group Inc. (AAL): Free Stock Analysis Report To read this article on Zacks.com click here. Zacks Investment Research