Oil prices have been on an uptrend this year, thanks to various reasons like the geopolitical tensions in the Middle East. In fact, oil prices have climbed more than 17% on a year-to-date basis. In line with the upsurge, oil prices jumped above $70 a barrel on May 4 due to concerns pertaining to the economic crisis in Venezuela- a major oil exporter- and the possibility of fresh sanctions on Iran by the United States. This marks a phenomenal turnaround for the commodity, which was trading at around $30 a barrel in 2016.
Airlines: Feeling the Heat
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 almost 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.
The gloomy picture for airlines in this respect can be gauged from the fact that shares of American Airlines Group Inc. AAL and Spirit Airlines, Inc. SAVE declined after the companies unveiled their respective first-quarter earnings results late last month. This was despite the carriers reporting better-than-expected earnings. High fuel costs were primarily responsible for the stocks shedding value. While average fuel price (consolidated and inclusive of taxes) increased 23.6% year over year at American Airlines, the metric surged 21.5% at Spirit Airlines.
Moreover, American Airlines trimmed its current-year earnings projection mainly on high fuel costs. The likes of Delta Air Lines, Inc. DAL and Alaska Air Group, Inc. ALK also saw their respective bottom line contract on a year-over-year basis mainly due to high fuel costs.
All the above-mentioned stocks carry a Zacks Rank #3 (Hold). You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here.
Disappointing Price Performance
The struggles of airline stocks chiefly due to surge in oil prices can be gauged from the fact that the Zacks Airline industry has shed 10.8% of its value so far this year.
Oil Price Surge Likely to Hurt in Q2
The upsurge in oil prices due to the above-mentioned reasons is likely to limit bottom-line growth for airlines in the second quarter as well. This is evident from the forecasts of various carriers on fuel costs for the current quarter.
For the second quarter, United Continental Holdings, Inc. UAL expects average fuel price per gallon (on a consolidated basis) between $2.18 and $2.23, which is higher than the first-quarter figure of $2.11. At Delta, the same is expected between $2.07 and $2.12 in the second quarter, higher than the first-quarter figure of $2.01.
American Airlines too expects to incur a higher amount in the second quarter on consolidated jet fuel (inclusive of taxes) compared with the first-quarter figure of $2.10 per gallon. Other carriers like JetBlue Airways Corporation JBLU and Southwest Airlines Co. LUV also expect to incur significantly higher costs on fuel in the second quarter of 2018.
Will Air Travel Become More Expensive?
In a bid to counter the challenges posed by surging oil prices, airlines are likely to increase air fares. They might pass on the increased costs to passengers to prevent profits from being dented. In fact, American Airlines' CEO, Doug Parker, too has hinted at higher ticket prices. Some market watchers believe that fuel surcharges may be added to tickets.
Already, Spirit Airlines has increased ticket prices (one-way) to the tune of $3 . Also, other carriers are anticipated to follow suite.
According to data released by the Bureau of Labor Statistics, average airfares (adjusted) in the United States have already increased in two successive months this year - February and March. With fuel costs eating into the profits of airlines, fares are anticipated to increase further in the current year.
However, according to Parker, even if air fares rise, they will not hurt the strong demand for air travel. An improving economy, a much-improved job market and rising disposable income have been the factors supporting the strong demand in the space. Also, consumer confidence remains strong resulting in more Americans going on vacations.
This optimism can be gauged from American Airlines' bullish second-quarter outlook on total revenue per available seat miles (TRASM: a key measure of unit revenues), despite fuel cost woes. TRASM is anticipated to increase in the band of 1.5-3.5%. Moreover, according to some market watchers this phase of higher fuel costs might promote capacity discipline. This a boon for carriers as woes related to capacity overexpansion had plagued airlines for quite some time.
With so many possibilities in the cards, we expect investors to remain focused on updates from the space as sector participants look to devise ways to eliminate threats from rising oil prices.
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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 JetBlue Airways Corporation (JBLU): 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 American Airlines Group Inc. (AAL): Free Stock Analysis Report Alaska Air Group, Inc. (ALK): Free Stock Analysis Report To read this article on Zacks.com click here. Zacks Investment Research