Airlines Face New Test Amid Rising Fuel Prices, Labor Costs
January 07 2017 - 7:29AM
Dow Jones News
By Susan Carey
Delta Air Lines Inc. is expected to kick off fourth-quarter
earnings results for U.S. airlines on Thursday, as the industry
faces a fresh test of its financial resilience amid rising fuel
prices and labor costs.
The sector has notched seven consecutive years of profitability,
the longest and strongest cycle in what has traditionally been a
turbulent industry prone to big booms and busts. While no one is
betting on a recession soon and airlines are expected to be
profitable this year, some investors are questioning how long the
winning streak can last.
Delta's results likely will telegraph the outlook for the
sector. The No. 2 carrier by traffic already has warned that higher
costs will shrink its operating margin in 2017 from last year's
solid 16.5% performance. Other big carriers are expected to report
later this month.
Cowen & Co. has lowered its ratings on five U.S. carriers on
signs that margins "are expected to compress" because revenue
growth isn't outpacing cost increases. The International Air
Transport Association trade group suggested that global airline
profits peaked in 2016 and will decline this year.
Meanwhile, low-cost carriers continue to gain market share. The
industry also remains vulnerable to external shocks such as
terrorism. Some analysts question whether airlines can wring more
revenue from fliers for perks such as advanced boarding and better
seats. Adjusted for inflation, domestic airfares have fallen by
more than a quarter since 1999.
Yet industry executives believe airlines are better prepared to
withstand a downturn than in any of the five downturns that have
battered the sector since 1980.
Doug Parker, chief executive of American Airlines Group Inc.,
the nation's largest by traffic, said, "Our projections, even in
difficult economic environments, have this company being nice and
profitable."
Bankruptcies after the 9/11 terrorist attacks were followed by a
series of mergers that left the top four U.S. airlines controlling
more than 80% of domestic capacity. These changes allowed them to
increase efficiency, repair balance sheets and funnel profits into
new products. Economic recovery since the latest recession ended in
2009, coupled with low fuel prices, gave airlines a strong
tailwind.
"This business is not only more durable and sustainable; it's
something you can count on for some time," Delta CEO Ed Bastian
said recently. Delta continues to aim for operating margins of 17%
to 19% in the future, targets that seemed unattainable a few years
ago.
Investor sentiment toward U.S. airlines has improved. Two months
ago, Warren Buffett's Berkshire Hathaway Inc. disclosed stakes in
American, Delta and United Continental Holdings Inc. that totaled
$1.3 billion -- even though he had previously spurned airline
shares, calling the business capital-intensive and not very
profitable.
Those investments are "an endorsement that things are different
this time," said Jamie Baker, a J.P. Morgan analyst. Mr. Baker
anticipates that airlines would remain profitable even if margins
slip to about 10%, the former peak.
Smead Capital Management, a Seattle-based investment firm, is
another investor that has changed its perspective. "Over the long
term, we thought airlines were a bad place to put capital," said
Tony Scherrer, research director for the Smead Value Fund. But the
fund recently placed its first bet on an airline stock by acquiring
a stake in Alaska Air Group Inc.
Not only has broader consolidation made the industry "a better
business now," he said, but Smead was attracted to Alaska's
business model and opportunity to gain from its recent acquisition
of Virgin America Inc.
Airlines also are adding fewer seats as traffic continues to
rise, helping to drive up fares. Unit revenue -- the amount earned
for each seat flown a mile -- is approaching positive territory
after two years of declines.
That the industry is checking its capacity growth "is lining up
as good for a recession scenario," said Kristopher Kelley, an
equity analyst at Janus Capital Group Inc., a Denver-based
investment manager with holdings in American, United and Southwest
Airlines Co.
Airlines also are hopeful about President-elect Donald Trump's
pledge to cut corporate taxes. "The potential impact of tax reform
on earnings and cash flows for the airlines is broadly positive,
but very company-specific," said David Vernon, a Sanford C.
Bernstein analyst.
Write to Susan Carey at susan.carey@wsj.com
(END) Dow Jones Newswires
January 07, 2017 07:14 ET (12:14 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.
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