There is no denying that stocks in the airline space are witnessing good times on the back of a number of tailwinds like improved unit revenues and financial prosperity. Despite the optimism, there are certain roadblocks one must be mindful of before investing in the sector. Let's delve into the details.
Rising Fuel Costs Hurting Bottom Line
Fuel costs are on the rise lately, with oil prices crossing the $60-a-barrel threshold. This upsurge can be attributed to the decision of OPEC member nations and Russia to extend production cuts to the end of 2018. This upsurge, however, does not spell good news for carriers.
As fuel costs represent one of the largest input costs for airline companies, the rise in oil prices naturally pushed up operating expenses, in turn, hurting the bottom line of carriers.
In fact, in the last three months, oil prices have increased significantly. The fact that fuel costs are on the rise can be made out from Delta Airlines' (DAL) fourth-quarter earnings report. Average fuel price (adjusted) was up 20.9% year over year to $1.93 per gallon at this Atlanta, GA-based carrier.
The scenario is unlikely to change this year. Delta, which carries a Zacks Rank #3 (Hold), expects fuel prices, including taxes and refinery impact, between $2.05 and $2.10 per gallon in the first quarter of 2018, which is much higher than the year-ago figure. You can see the complete list of today's Zacks #1 Rank (Strong Buy) stocks here.
Moreover, the International Air Transport Association ("IATA") projects that jet fuel prices will escalate around 12.5% to $73.80 per barrel in 2018. The fuel bill is likely to account for 20.5% of total costs in 2018 (18.8% in 2017).
Labor-Related Issues - Another Drag
Apart from the rise in fuel costs, the surge in labor expenses is hurting the bottom line of carriers. This is primarily due to deals inked by carriers with various labor groups.
Evidently, the improved financial health of the carriers has not gone unnoticed by their employees, who are eager to get a share of the pie. This has propelled frequent new labor deals across the airline industry.
Even in the ongoing fourth quarter of 2017, labor costs have limited the bottom-line growth of carriers. For example, at American Airlines Group (AAL), expenses pertaining to salaries and benefits were up 7%. This was primarily due to the significantly higher pay offered to pilots by the company to operate unassigned flights during the busy winter travel period.
This followed the infamous scheduling glitch, which allowed pilots of the carrier to take leave during the winter holiday period, giving rise to an acute pilot shortage during the busy travel period. The crisis was finally averted after talks between the company and its pilots' union - Allied Pilots Association.
The surge in labor costs is augmented in IATA's forecast for 2018. According to the projection, expenses related to labor are expected to be the largest expense item for airlines this year. Labor costs are projected to account for 30.9% of total expenses, and total unit costs are expected to increase 4.3% (much higher than the 1.7% increase in 2017).
Moreover, issues related to labor strife have been hurting airlines quite a bit. Recently, Irish carrier Ryanair Holdings' (RYAAY) pilots resorted to a four-hour strike. This was reportedly the first time its pilots ever struck.
Computer Glitches Hurting Airline Operations
American Airlines is not the only carrier to suffer from a scheduling glitch. A similar issue had hurt Ryanair Holdings. According to a CNBC report , the carrier had to cancel 2,000 flights, resulting in significant customer dissatisfaction.
Technical glitches, in fact, have been creating a nuisance for carriers. For example, in November 2017, a computer glitch disrupted operations at Southwest Airlines (LUV). Operations at British Airways were also crippled last year due to a major IT system failure. Since expenditure on technological infrastructure is significant for stocks in the airline space, their profitability might be hurt in the event of such malfunctions.
Capacity-Related Woes & Declining Airfare
Woes related to capacity overexpansion plagued airline stocks in the not so distant past (particularly 2015). These fears were re-ignited when United Continental Holdings (UAL), while releasing fourth-quarter results on Jan 23, stated that it expects 2018 capacity growth between 4% and 6% year over year. Moreover, similar growth in the metric is forecast for 2019 and 2020. Following the guidance, investors fear that similar actions might be taken by rivals, triggering a price war.
Capacity expansion may lead to oversupply in the market even as fuel costs remain well below the highs of mid-2014, despite the recent resurgence. Moreover, airfares have remained low, with the metric declining in November. Capacity over-expansion is believed to be the primary reason for the decline in airfares. Low air fares are favorable for fliers but a drag on the top line of carriers due to their lesser profits.
Issues related to passenger dissatisfaction have been hurting U.S. carriers for quite some time. Alaska Airlines, the wholly owned subsidiary of Alaska Air Group (ALK), was the latest sufferer in this regard, when it was reportedly sued by the family of an elderly lady who died last year following a fall in an escalator at the Portland, OR airport.
Natural calamities have also been responsible for laying airlines low by disrupting their operations. The latest such instance came when winter storm Grayson wreaked havoc in January 2018. With the storm disrupting normal life, travel plans were thrown as major airline operators had to cancel multiple flights.
Moreover, it is a well-documented fact that acts of terrorism have the potential to harm airline stocks due to the possibility of waning travel demand due to security fears. The deadly mass shooting in Las Vegas on Oct 1, 2017, hurt travel to the gambling haven, thus impacting tourism as Las Vegas is a popular tourist spot.
The Orlando mass shooting in June 2016 led to the crashing of airline stocks. Other acts of terror across the globe like the 2015 Paris and the 2016 Brussels attacks also spelled doom for airlines.
Thus the airline industry, despite the air of optimism surrounding it, is not bereft of headwinds. The challenges may prove to be detrimental to investors, especially the risk-averse ones, unless attention is paid to resolve the above issues.
Check out our latest Airline Industry Outlook for more news on the current state of affairs in this market from an earnings perspective, and how the trend looks ahead for this important sector at the moment.
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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 reportUnited Continental Holdings, Inc. (UAL): Free Stock Analysis ReportRyanair Holdings PLC (RYAAY): Free Stock Analysis ReportSouthwest Airlines Company (LUV): Free Stock Analysis ReportDelta Air Lines, Inc. (DAL): Free Stock Analysis ReportAlaska Air Group, Inc. (ALK): Free Stock Analysis ReportAmerican Airlines Group, Inc. (AAL): Free Stock Analysis ReportTo read this article on Zacks.com click here.Zacks Investment Research