| Beyond the 737 MAX: What Airline Investors Should Really Obsess Over -- Barrons.com|
DOW JONES & COMPANY, INC. 1:54 PM ET 7/9/2019
Symbol Last Price Change
|BA ||352.65 ||+1.53 (+0.44%)|
|DAL ||58.755 ||-0.615 (-1.04%)|
|LUV ||51.62 ||-0.46 (-0.88%)|
|AAL ||31.995 ||-0.795 (-2.42%)|
|QUOTES AS OF 03:01:47 PM ET 07/09/2019 |
Wall Street airline analysts are spending a lot of time thinking about the 737 MAX, yet the MAX barely cracks the top five issues airline investors should be worried about. The impact of the worldwide grounding of Boeing's(BA) troubled single-aisle jet has on the industry is small and will be temporary.
Analysts can be forgiven for their focus on the Boeing(BA) MAX plane. Second-quarter earnings are coming - - Delta Air Lines(DAL) reports Thursday morning -- and the MAX will surely affect those numbers.
Bernstein analyst David Vernon points out in a Tuesday research report that carriers with less MAX exposure, such as Delta and United Airlines Holdings (UAL), are expected to grow earnings per share by more than 20%. Carriers with more MAX exposure, such as Southwest Airlines(LUV) and American Airlines Group(AAL) , are expected to grow earnings less than 5% in the second quarter.
That sounds like a big gap, and it's causing some analysts to rethink their stock ratings. Yet they're are saying opposite things based on the same information.
Monday, Credit Suisse analyst Jose Caiado downgraded shares of American Airlines(AAL) to Underperform, the Credit Suisse equivalent of a Sell rating. American operates 24 MAX jets, and the grounding is increasing its operating costs.
But also on Monday, Evercore ISI analyst Duane Pfennigwerth wrote investors should buy American Airlines(AAL) shares now because lower industry capacity is good for everyone and because they trade at a discount to other airlines. The shares trade for less than six times estimated 2020 earnings, a 25% discount to the sector.
The difference between the two analysts' views amounts to market timing. American, according to Caido, should recover when the MAX is flying commercially again. That's a helpful insight for traders, but less helpful for long-term investors.
There is, however, plenty long-term investors should be thinking about beyond the 737 MAX, including oil prices, labor relations, demand for air travel, and how the industry is structured. Here's our take on these four other factors that should obsess airline investors.
Jet fuel is often the largest expense for an airline. Benchmark crude prices, which are nearly perfectly correlated with jet fuel prices, dropped 38% in the fourth quarter and bounced back, rising 32%, in the first quarter. Overall, from the end of third quarter 2018 to the end of first quarter 2019, oil prices dropped $15 a barrel.
Lower oil prices mean lower costs, and that should be good for airline stock prices. Airlines shares, however, dropped about 15% over that span, while the Dow Jones Industrial Average was just about flat. Airlines like lower costs, but what airlines don't like is cost volatility. It makes pricing air tickets harder and raises questions about economic growth.
American Airlines (AAL) shares could be lagging behind the market because of the company's 737 MAX exposure, but the airline is also dealing with significant labor issues. It is in the midst of a court case against its own employees, alleging a concerted effort by mechanics to disrupt airline operations.
Stifel analyst Joseph DeNardi attended that trial and argues that American's operational challenges will persist. What's more, he thinks the outcome of the trial and any subsequent negotiations has big implications for the entire industry.
"The resolution of this contract and what it means financially will be a crucial point in the ongoing debate over whether it is different this time or whether the airline industry remains a challenging place for investors to make money through the cycle," he wrote in a July 1 research report.
Mechanic contracts aren't the only issue facing the sector. United is also negotiating with its pilots, and Delta's pilot contract becomes amendable at the end of 2019. Southwest's(LUV) and American's pilot contracts aren't amendable until 2020.
Demand for Air Travel
"After the strong [airline] traffic growth seen in the last two years (about 7% on average), traffic growth in 2019 has moderated," Vertical Research Partners aerospace analyst Rob Stallard wrote last week. Stallard, who covers aerospace companies, is concerned that slower traffic growth will hurt demand for parts and services, but slower growth in air travel hurts airlines too.
Airlines have enjoyed a decade of demand growth. The number of passengers getting on planes in the U.S. hasn't dipped year over year for two consecutive months since 2013, according to the Transportation Department. What's more, demand for air travel hasn't experienced a yearly decline since 2010, in the wake of the financial crisis.
Growth in demand has led to a long string of airline profits. In fact, no major U.S. airline has reported a pretax loss since 2013. Still, investors are paying only about eight times estimated 2020 earnings for the sector -- a 50% discount to the market -- because of lingering concerns about profit performance in a recession. Those fears persist despite industry consolidation, which has reduced the number of major U.S. carriers from seven to four.
There is a lot to consider for investors who might believe airline stocks are a good place to look for value in a stock market that is setting record highs seemingly every week. To buy into airline shares, investors need to believe that this time is different -- and that airlines will remain profitable despite some of the challenges detailed above.
Write to Al Root at email@example.com