Can Airline Stocks Withstand Higher Crude Oil Prices? - Analyst Blog

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Stocks in the airline space have been performing impressively over the last few months thanks to higher demand for travel backed by an improving labor market, consolidation and declining oil prices . Lower jet fuel prices have positively impacted the airline industry given the inversely proportional relation between crude prices and the value of stocks.

Crude prices have remained weak over the recent past due to an over-supplied oil market, especially in the face of lackluster global demand. Since fuel costs account for a major chunk of an airline company's operating expenses, the drop in oil prices has significantly boosted the bottom lines of stocks in the airline space.

In fact, the financial results of most airline stocks in the closing quarter of 2014 benefited from low fuel costs. Carriers such as Delta Air Lines DAL , Alaska Air Group ALK Southwest Airlines LUV and American Airlines Group AAL recorded better-than expected earnings in the fourth quarter of 2014. Although it is a fact that most carriers hedge at least some of their fuel costs, the majority of them should still continue to benefit considerably from the plunge in oil prices. Notably, carriers use a combination of calls, swaps and collars at varying WTI crude-equivalent price levels to hedge fuel costs.

Recent Oil Price Rise Not a Concern

More lately, airline stocks have fluctuated with respect to price performance, in response to the volatile nature of oil prices. Over the last few weeks, oil prices have been rising albeit not substantially. Crude prices have been hovering around the $50 a barrel mark. This represents a significant decline from the approximately $105 per barrel witnessed in July last year. In fact, oil prices have been fluctuating wildly after hitting a 6-year low of under $44 in Mar 2015.

We are not too perturbed by the recent upward movement in oil prices. We believe the adverse impact of the rise on airline stocks is nothing but a short-term phenomenon.

We say this in view of the fundamentals of the industry that remain strong. Thus, stocks in the airline space should gain over the long term. We expect oil prices to continue fluctuating and it is highly unlikely that they will touch the highs of 2014 any time soon. As seen over the recent past, weak oil prices should translate into big gains for airline stocks over the long term.

This optimism is supported by the rosy outlook for 2015 provided by the International Air Transport Association (IATA). The research firm projects that the industry will continue to see good times in 2015. IATA has projected a rise in the industry's global profit to $25 billion in 2015 from $19.9 billion in 2014.

The research firm has also predicted that airline companies will earn $7.08 per passenger in 2015, up 17.6% year over year. The firm further holds that oil prices will continue to fall this year with the average price hovering around $85 per barrel.

Strong Financial Health Promotes Investment in Infrastructure

The massive savings enjoyed by most airline stocks have naturally turned around their financial health. This has prompted them to invest substantially toward enhancing the flying experience for travelers, in a bid to stay afloat in the competitive airline space. For example, American Airlines announced last year that it will invest in excess of $2 billion to upgrade its flying facilities. In the same vein, Delta Air Lines introduced a new five-tiered seating plan from Mar 1, 2015. According to Boeing, over the next 20 years, globally, airline companies are expected to invest around $5.2 trillion in fleet development.

Carriers have been investing heavily toward fleet expansion. For instance, in February, Allegiant Travel Company ALGT , the parent company of Allegiant Air, announced a deal to buy two A320 planes. At present, the aircraft, which has a capacity of 177 seats, is being used by Philippine Airlines. The twin A320 aircraft will join the company's fleet before the end of 2015.

Thus, low oil prices are indeed a blessing for the financial health of airline companies. We expect these good times to continue for quite some time ahead, and so do the carriers, as can be made out by the long-term investments planned by them.

The Bottom-Line

Even though oil prices are betraying a marginal upward trend, we believe prices are unlikely to touch the highs witnessed early last year. Consequently, airline stocks should continue to gain and the industry as a whole should still witness joyful times. With oil prices expected to remain weak and ticket prices not showing substantial change, airline stocks should appreciate going forward.

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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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