Will Profits in the Airline Space Scale New Highs in 2016?
2:40 pm ET December 11, 2015 (Zacks) Print
Airline stocks will likely continue their bull run into 2016 as has been reinforced by the encouraging outlook provided by the International Air Transport Association (IATA) recently. The trade association now expects profits in the aviation industry to touch $36.3 billion in 2016 with a net profit margin of 5.1%.
IATA also projects profits of around $33 billion in 2015 with a net profit margin of 4.6%, marking an improvement from the previous guidance of $29.3 billion which was released in Jun 2015.
Impact on U.S. Airlines
Following the rosy profit outlook, stocks of the U.S. airlines industry had a bullish yesterday. Notably, Delta Air Lines Inc. DAL, United Continental Holdings UAL and Spirit Airlines SAVE rallied the most with a respective gain of 3.58%, 2.89% and 2.79%, in yesterday’s trading session.
Factors Justifying the Bullish View
Fuel Price Effect: Airline profits largely depend on fuel prices which form nearly 30% of operating expenses and are also the major variable component in the industry. The firm holds that oil prices will continue to fall this year with the average price hovering around $55 per barrel of Brent crude. Likewise, in 2016, price of Brent crude is expected to decline further to $51 per barrel, thereby driving earnings for the overall aviation industry.
Solid Travel Demand: The busy Labor Day holiday period (Sep 2–8) and the Thanksgiving rush (Nov 20–Dec 1) will certainly drive profits beyond 2015. Moreover, Christmas holidays and summer vacations will contribute to traffic. IATA projects 6.7% and 6.9% growth in air traffic in 2015 and 2016 with load factor or percentage of seats filled by passengers pegged at 80.7%.%. IATA also believes that 3.8 billion passengers will travel in 2016.
Improving Economic Scenario: An improvement in U.S. economic conditions and strong recovery in most European nations continue to boost profits for airline carriers. In the U.S., unemployment rate stands at 5% which is quite encouraging while the U.S. Department of Commerce reported in its “second” estimate that the economy grew at a pace of 2.1% in the third quarter, compared to the earlier projected growth rate of 1.5%. Likewise, global GDP growth is forecasted at 2.7% for 2016 compared with 2.5% in 2015.
Improved Carrier Efficiency: Increased fleet restructuring programs retiring older and less efficient aircraft and placing new aircraft orders are anticipated to enhance the performance level of the company by trimming fuel and operating costs, and rendering a comfortable flying experience. Moreover, most carriers are focused on augmentation of ancillary revenues by launching value-added services at affordable rates. For example, JetBlue Airways Corp. JBLU has initiated Mint service which is gaining considerable popularity. Recently, American Airlines Group Inc. AAL rolled out Premium Economy service for its international customers. These value-added services are expected to retain customers and also ancillary revenues.
Region-Wise Contribution
North America continues to dominate more than half of the aviation industry with an expected profit of nearly $19.4 billion and $19.2 billion for 2015 and 2016, respectively. IATA also believes that the airline companies in North America will earn the maximum profits of $21.44 per passenger in 2016 against other regions with a net profit margin of 9.5%. Also, capacity expansion by North American airlines is anticipated to increase from 3.7% in 2015 to 4.8% in 2016 based on U.S. economic growth.
The other regions, namely, Europe, Asia-Pacific and Middle East are expected to generate post-tax net profit of $6.9 billion, $5.8 billion and $1.4 billion, in 2015 with profit margin of 3.5%, 2.9% and 2.3%, respectively.
However, Latin America and Africa are expected to incur loss of $1.05 billion and $3.84 billion, respectively, in the same period. Such a gloomy outlook for Latin America is mainly attributable to economic crisis in Brazil, adverse currency movements, and soft commodity prices. Similarly, an unstable political scenario and stiff competition from other international carriers have led to the somber outlook for Africa.
Likewise, for 2016, the profit guidance outside North America which include Europe, Asia-Pacific, Middle East and Latin America are estimated to produce post-tax net profit of $8.5 billion, $6.6 billion, $1.7 billion and $0.4 billion, respectively, and profit margin of 4.3%, 3.2%, 2.6% and 1.1%, respectively. However, Africa is anticipated to incur a loss of $0.1 billion.
Concerns Remain
Despite the strong profit outlook set by the IATA, we believe that earnings at the aviation industry will be offset by headwinds like travel alert stemming out of random terror attacks, strong U.S. dollar and labor-related issues. These negatives resulted in a 13% decline in the NYSE ARCA Airline index through the first eleven months of 2015.
In addition, declining air fares due to capacity expansion may also impact the top line of airline companies, thereby affecting profits. As per data released by the Bureau of Labor Statistics, airfares in Jul 2015 (on a seasonally adjusted basis) decreased 5.6% from Jun 2015. This decline marked the sharpest monthly drop since Dec 1995. Further, airfares declined 3.1% in the month of August.
The Bottom Line
We expect carriers to continue demonstrating impressive bottom-line growth going forward as oil prices are unlikely to touch the highs witnessed in mid-2014 anytime soon. Moreover, a higher demand for travel on the back of an improving labor market and consolidation should further aid carriers.
