Airline Industry Stock Outlook - Nov. 2015

Weak Oil Drives Q3 Earnings Performances

The series of earnings beats by airline companies has reinforced the well-documented fact that soft oil prices are nothing short of a godsend for stocks in the aviation space. Delta Air Lines Inc. ( DAL ) kick-started the third quarter earnings season for airline stocks on Oct 14, with a positive earnings surprise of 1.75%, courtesy of weak oil prices.

Other major carriers like American Airlines Group ( AAL ), United Continental Holdings ( UAL ), JetBlue Airways ( JBLU ) and Southwest Airlines ( LUV ) followed Delta in delivering third quarter earnings beats on the back of low fuel costs. Needless to say, the oil glut that has been on for well over a year now has resulted in massive savings for carriers.

For example, American Airlines Group, which does not hedge fuel costs, expects to generate savings of approximately $5 billion in 2015. The robust financial health of most U.S. carriers has prompted them to invest substantially toward improving the flying experience for travelers, in a bid to stay afloat in the competitive airline space.

Additionally, financial stability has allowed for the launch of share repurchase programs, increased dividend payments and significant reduction of debt levels at the companies. On its third quarter conference call, American Airlines announced that its board has authorized an additional $2 billion share buyback program that is expected to be completed by Dec 31, 2016.

However, as in the second quarter, revenue growth was sluggish in the third quarter as well, owing to the dollar's strength.

Oil Weakness Key to IATA's Bullish Forecast

That airline stocks are likely to continue their profitable run through the rest of 2015 had been hinted at by the International Air Transport Association's (IATA) rosy forecast earlier in the year. The trade association now expects profits from the aviation industry to touch $29.3 billion in 2015 as opposed to the earlier projection of $25 billion, thanks to weak oil prices.

The bulk of the global profits ($15.7 billion) is expected from the North American region. The other regions, namely Asia-Pacific, Europe, Latin America, Middle East and Africa, are expected to generate post-tax net profit of $5.1 billion, $5.8 billion, $0.6 billion, $1.8 billion and $0.1 billion, respectively. Global net profit margin is expected to expand to 4% in 2015. However, global revenues are anticipated to decline 0.7% to $727 billion, mainly due to the strength of the dollar.

The IATA suggests that demand for passenger travel will improve in 2015 from 2014 levels, thanks to an improving economy. Customers will benefit from cheaper air travel, thanks to low oil prices, as one-way fares are expected to be slashed by 9.3% this year. According to the forecast, load factor (% of seats filled by passengers) for 2015 is expected to touch a record-high of 80.2%.

The research firm has also predicted that airline companies will earn $8.27 per passenger in 2015, up 67.4% year over year. The firm holds that oil prices will continue to fall in 2015 with the average price in the year hovering around $78 per barrel, down 33%.

The busy Labor Day holiday period (Sep 2-8) enjoyed by U.S. carriers this year further highlights the current prosperity. Moreover, the monthly global traffic numbers released by the IATA for September highlight the increased travel demand. Global travel demand improved 7.3% during the month.

Load factor climbed to 80.7% as traffic growth outpaced capacity expansion which was up 6.6%. International travel demand (up 7%) was driven by strong performance of carriers mainly from North America, the Asia-Pacific, Latin America, Europe and the Middle East while strong numbers from India, Russia and China resulted in a healthy increase in domestic traffic (up 7.8%). In Aug 2015, global travel demand had improved by 7.1%.

Not All Roses, Some Brickbats as Well

Despite the massive fall in airlines' largest input cost, it has not been all smooth sailing for them this year. The industry has experienced quite a few challenges led by capacity and pricing worries. Investors feared that airline capacity growth at a rate higher than the U.S. GDP will lead to an oversupplied market.

The worries originated in May 2015, courtesy Southwest Airlines' announcement of its plans to raise its capacity in the band of 7% to 8% in 2015 as opposed to the earlier projection of a 7% increase. However, following widespread investor panic, the carrier reverted to a 7% capacity growth plan and reiterated the same in the recent third quarter 2015 conference call.

Moreover, the ongoing weakness in passenger revenue per available seat mile (PRASM: a measure of unit revenue), which has hurt stocks in the space, can also be attributed partly to weak oil prices, making it a double-edged sword for carriers. Currency headwinds, coupled with lower fuel surcharges on international flights due to weak oil prices, pressurized this key metric.

Furthermore, a series of ongoing probes have hurt airline stocks. For instance, the ongoing internal investigation as well as the federal probe pertaining to United Continental Holdings' alleged improper dealings with the Port Authority of New York and New Jersey resulted in a change at the helm of the carrier. As a result of the probe, Jeff Smisek resigned in Sep 2015 from his roles as chairman, president and CEO and as a director of United Continental.

On the other hand, the U.S. Department of Justice sued United Continental to block the carrier from acquiring 24 take-off and landing spots from Delta at the Newark Liberty International Airport in New Jersey. The Justice Department filed the lawsuit to prevent United Continental from expanding further at its New Jersey hub, in a bid to protect competition and prices at the airport.

The ongoing dispute between leading U.S. carriers and their Gulf counterparts also raises concerns. In fact, Delta, which will apparently exit the Airlines for America Trade Association next year, will stop flying to Dubai from Atlanta effective early next year, due to excessive competition from Middle East carriers.

Zacks Industry Rank

Within the Zacks Industry classification, airlines are broadly grouped into the Transportation sector (one of the 16 Zacks sectors).

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 #48 for the "Trans-Airline" segment places it at the top 1/3rd of the 260+ member industry group and indicates the group's near-term Positive outlook. With oil prices unlikely to touch the highs witnessed in mid-2014 anytime soon, airline companies should continue to display impressive bottom-line growth going forward. Moreover, a higher demand for travel on the back of an improving labor market and consolidation are further reasons validating the bullish Zacks Rank on the airline industry despite the headwinds discussed above.

Earnings Trends

The airline industry falls under the broader transportation sector. With all the S&P 500 members in the transportation space having already announced their third-quarter 2015 earnings results, the aggregate earnings beat ratio is an impressive 85.7%. On the other hand, the revenue beat ratio is just 28.6%. Average earnings growth is 22.5% while year-over-year top-line growth has treaded into the negative territory and stands at a negative 1.3%.

For more details about earnings for this sector and others, please read our Zacks Earning Trends report.

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UNITED CONT HLD (UAL): Free Stock Analysis Report

SOUTHWEST AIR (LUV): Free Stock Analysis Report

JETBLUE AIRWAYS (JBLU): Free Stock Analysis Report

DELTA AIR LINES (DAL): Free Stock Analysis Report

AMER AIRLINES (AAL): 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.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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