Capacity growth and utilization
For the airline industry, growing capacity is necessary for revenue growth. However, capacity expansion that exceeds demand growth can lead to declining utilization. This would mean higher costs and can negatively impact yield.
Declining load factors and unbridled capacity expansion resulted in pricing wars in the industry, which was the case throughout 2015. If airfares decline, yields would decline further. On the other hand, if airlines can increase airfares further, yields could improve.
Oil prices comprise a major cost component of airlines, and the 50% decline in crude prices has helped improve margins. Analysts do not expect airlines to significantly benefit from improved fuel costs.
However, the greater risk is from increasing oil prices if the airlines cannot pass the cost savings on to their passengers. Fuel prices have declined tremendously, and it is only a matter of time before crude oil could bounce back. On the other hand, a further decline in fuel prices could be positive for the industry.
Airline profitability has improved tremendously and is at highest levels historically. Analysts are estimating margins to have peaked. Investors should keep a close eye on airline profitability and more importantly, analysts’ forecast for the industry’s future margins.
Industry fundamentals have improved tremendously in the last two years. Reducing leverage at such a time would not only reduce interest cost, but this would make companies with lower leverage an option for investors.
Investors can gain exposure to airline stocks through the PowerShares Dynamic Leisure & Entertainment Portfolio ETF (PEJ) invests 4.8% of its holdings in Southwest Airlines (LUV). It also invests 5% of its holdings in Delta Air Lines (DAL), American Airlines (AAL), and United Airlines (UAL) each. PEJ invests 2.7% in Alaska Air Group (ALK), 2.5% in Allegiant Travel Company (ALGT), and 2.4% of its holdings in JetBlue Airways (JBLU).
We will provide regular updates on all the indicators mentioned above, so please visit our Airlines page regularly.