U.S. Airlines Rise and Shine

After sluggish years following 9/11, the US airline sector is looking bright. The AMEX Airline Index outperformed the market (S&P500 +21.67%) by gaining 64.67% in the last 12 months.

All American carriers will report profits in the third quarter 2013 according to analysts’ consensus surveyed by Bloomberg. Prior to Q3 earnings announcement in the week of October 21, analysts expect a 27% year-over-year earnings increase across the industry. “Airlines are generating cash and increasingly using that cash to buy back stock, pay dividends and decrease debt,” said S&P Capital IQ analyst Jim Corridore in an email interview.
Deutsche Bank recently raised its net profit estimate for the U.S. airline industry to $2.9 billion for Q3 2013, up 53% from last year. Higher travel demand has driven this growth, which led to a 5.8% jump in passenger revenue per available seat mile (PRASM). Also, the jet fuel bill is expected to be down 1.1% to $11.4 billion in Q3 2013.

 

Capacity will be the key issue for airlines to sustain current profits. Over the next 12 months, analyst Corridore expects U.S. airlines to focus on increasing yields and airfares while not scale up capacity. Domestic capacity decreased by 0.7% year-over-year in September 2013. “I think airline executives have learned the hard way that its better to be more cautious and muted on capacity growth, but it’s something I watch more than most other things,” Corridore said. He would start worrying if capacity increased 2% faster than GDP.

 

Most analysts expect Delta, Alaska and Spirit Airlines stock to rise in the near future. “Delta has largely completed its merger integration [with Northwestern Airlines] and is generating a unit revenue premium to peers and is fixing its balance sheet, buying back stock and using its capital creatively as when it bought the oil refinery,” said Corridore who has a “Buy”-opinion on the market-leading airline. Delta stock was trading for $25.01 on Friday while its 12 months average target price is predicted to be $29.50.

 

But not all airlines are doing that well. S&P Capital IQ currently recommends selling JetBlue stock. “We think JetBlue’s recent moves to try and undersell competitors on transcontinental flights and its focus on the transcontinental market rather than on niche markets where it can gain leverage and competitive advantage is a poor strategy,” Corridore said. “We also think the shares look pricey on a valuation basis.” S&P Capital IQ’s 12-month target price ($6.00) is lower than both analyst average target price ($7.45) and current stock price ($7.28 on Friday).

Fuel prices volatility and geopolitical issues could potentially shake up the industry. “Every one cent move in the price of jet fuel (per gallon) will impact industry pretax profit by $170 million,” according to Deutsche Bank Sept Q 2013 Preview.

The government shutdown didn’t impact the airline industry significantly. But closing down the Department of Justice for two weeks might delay the antitrust lawsuit against the planned merger between US Airways and American Airlines.

The $11 billion merger between US Airways and bankrupt American Airlines would result in the world largest airline. The market is favorable to the potential merger as it might decrease competition and therefore lift stocks. But DOJ challenges the merger as leading to higher prices and less service for customers.

“In the long run if the merger is not to be allowed, American Airlines may not be able to survive and there would be much more harm to the consumer,” said Corridore.