Falling crude helps build capacity
Jet fuel forms a major cost component for airlines. Global crude prices have fallen more than 60% since hitting historic highs. This has helped airlines to reduce costs tremendously, generating huge profits and surplus cash. Higher travel demand has helped too.
The cash surplus has given airlines the opportunity to increase capacity, which is measured by available seat miles (or ASM).
Major US airline capacity increased by 9.6% year-over-year (or YoY) in January 2016, slightly lower than the 10% average growth seen in 2015.
Ultra-low-cost carrier Spirit Airlines (SAVE) added the highest capacity, but the addition was less than its 30% growth in 2015. This was followed closely by Allegiant Travel (ALGT), higher than its 18% growth in 2015. Their capacities grew by 26.8% and 19.5%, respectively, in January 2016.
JetBlue Airways (JBLU) also increased capacity at a greater pace than in 2015, at 11% YoY growth in January 2016 compared to 9.5% growth in 2015. Alaska Air Group (ALK) also saw double-digit capacity growth of 12.4% during the month, higher than its 10.6% growth. Delta Air Lines (DAL) saw low single-digit growth.
Historically, airlines are known to overdo capacity expansion in good times, only to repent when cycles turn, which they eventually will. Overcapacity leads to falling utilization. In times of low demand growth, airlines then resort to aggressive pricing to fill their seats. This puts pressure on yields, ultimately leading airlines to losses.
2016 so far suggests a different story, with airlines having raised airfares at least five times since the start of the year. Industry consolidation has definitely helped in this case, as it has reduced the forces that caused past capacity growth and price wars.
However, demand growth still supports the expansion spree of airlines. Most players have trimmed down their capacity growth guidances for upcoming quarters, which is a good sign for the industry.
Investors can gain exposure to airlines through the PowerShares Dynamic Leisure & Entertainment ETF (PEJ), which invests ~27% of its portfolio in airline stocks.