Despite the massive benefits reaped by airline stocks, courtesy the downswing in oil prices , the industry still has several hurdles facing it. Issues like capacity woes, declining passenger revenue per available seat mile (PRASM), multiple probes and labor strife continue to hurt stocks in the aviation space. These headwinds resulted in the NYSE ARCA Airline index losing over 11% through the first ten months of 2015.
We hereby discuss a few key factors that investors should watch out for when investing in the airlines sector.
It is no secret that pricing and capacity worries have plagued airline stocks for most of 2015. The concerns originated in May 2015, courtesy Southwest Airlines' ( LUV ) 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. 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.
The fact that capacity fears are not a thing of the past was reflected again when shares of low-cost carrier JetBlue Airways Corporation ( JBLU ) declined on Oct 27 despite recording higher-than-expected revenues and earnings in the third quarter of 2015. The company voiced its expectation of a capacity increase in the band of 8.5% to 10.5% for the fourth quarter and in the band of 8.5% to 9.5% for full year 2015. The prior guidance had hinted at a capacity expansion at the higher end of the 7% to 9% range for 2015. This increased capacity guidance for 2015 triggered fresh capacity-related fears among investors, dragging the stock down.
Stocks in the airline space have been hurt by the continuous decline in PRASM, a measure of sales relative to capacity for a carrier. For example, consolidated PRASM at American Airlines Group ( AAL ) declined 6.8% to 13.16 cents in the third quarter of 2015. The metric is projected to decline in the range of 5% to 7% in the fourth quarter. PRASM at Delta Air Lines Inc. ( DAL ) declined 5% year over year in the third quarter to 14.10 cents mainly due to currency fluctuations. The metric is projected to decline in the band of 2.5% to 4.5% in the fourth quarter.
In fact, the 0.6% decline in PRASM at JetBlue in the third quarter was responsible for the stock losing value on Oct 27, 2015, apart from the increased capacity guidance discussed above. Evidently thus, PRASM has, for quite some time now, become the Achilles' heel of airline companies.
Moreover, Delta will apparently exit the Airlines for America Trade Association next year as it aims to make "better use" of the annual membership fee it paid to the trade group. Apparently, the carrier did not see eye to eye with other members on some key issues. Whatever the reason, we believe the exit of such a high-profile airline player from the group cannot be seen in a very positive light.
Threat from Low-Cost Carriers
To add to the pain, the emergence and the subsequent growth and success of low-cost carriers like Spirit Airlines, Inc. ( SAVE ) and Southwest Airlines have made legacy carriers rather uneasy. In a price-conscious economy, it is not just the survival of the fittest, but of the cheapest.
The graveness of the issue became even more glaring when American Airlines declared on its third quarter conference call that it intends to offer exclusive low-priced air tickets, starting next year. The carrier laid bare certain statistics to back its claim about the burgeoning of low-cost carriers and the consequent threat they pose to legacy airlines.
In fact, American Airlines is not the first legacy carrier to be bothered about the threat from low-cost rivals. Delta Air Lines already offers inexpensive "Basic Economy" tickets to its customers.
Regular probes and disputes are a constant bother for stocks in the airline space. American Airlines, along with Delta Air Lines, United Continental Holdings and Southwest Airlines, is being probed by the Department of Justice on the possibility of unlawful co-ordination to limit the availability of seats with the objective of keeping airfares high.
On the other hand, 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.
Furthermore, the U.S. Department of Justice recently 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 is another challenge confronting the industry. Delta, American Airlines and United Continental had jointly complained to the Obama administration that the massive subsidies and other benefits enjoyed by the three Gulf-owned airlines - Qatar Airways, Etihad Airways and Emirates - were rather unfair in nature as they denied a level playing field to the American carriers. The conflict encountered a fresh twist in August, with a report in the Wall Street Journal suggesting that Etihad Airways had received $2.5 billion from the Abu Dhabi government last year.
No Respite for Latin American Carriers
Meanwhile, Latin American air carriers continue to suffer the brunt of a weak economy and currency headwinds. Such adversities have left companies like GOL Linhas Aereas Inteligentes ( GOL ) and Copa Airlines, the wholly owned subsidiary of Copa Holdings ( CPA ), in a sorry state. The gloomy 2015 outlook provided by the International Air Transport Association (IATA) with respect to Latin American carriers has made matters worse. The projection states that these carriers will account for only $600 million of the estimated $29.3 billion global net profit in 2015.
Labor-related headwinds are further challenges that airlines have to encounter on a regular basis. In Nov 2015, pilots at Southwest Airlines rejected a contract pertaining to their pay with 62% of them voting against the deal. In September, the company had inked an "agreement in principle" with the union. However, the pilots turned down the tentative contract on two major grounds, as per media reports.
Apparently, the issues pertained to code share agreements and "retro pay." With the previous contract having already expired in 2012, pilots demanded that they be compensated for the difference in pay between the old structure and the proposed new scheme. The compensation offered by the company apparently failed to match the pilots' demand.
With the contract being rejected in its present form, discussions will commence again (expected in the spring of next year) between the two parties as per the rules of the National Mediation Board. Labor issues continue to hurt operations at Germany's Deutsche Lufthansa Aktiengesellschaft ( DLAKY ) as well.
Moreover, technical glitches are the latest source of nuisance for carriers. For example, several flights of Southwest Airlines were delayed last month owing to a software glitch that caused immense harassment to passengers. The problem was first detected in the morning of Oct 11, 2015, and persisted till the evening. As per the Dallas-based carrier, nearly 450 out of the 3600 flights scheduled for departure were postponed during the day.
Such glitches have also been witnessed at carriers like United Continental this year. As technological infrastructure constitutes a key expense for airline companies, the profitability of carriers could be potentially affected in the event of such technology malfunctions.
The Bottom Line
The above challenges confronting the industry, unless addressed quickly, have the potential to limit the growth prospects of stocks in the space. The headwinds can lead to investors, especially the risk-averse ones, shying away from investing in the sector.
Check out our latest Airline Industry Outlook here for more on the current state of affairs in this market from an earnings perspective, and how the trend is looking for this important sector of the economy now.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.