By David Sterman
For nearly two years, investors have had to climb a wall of worry with regards to airline stocks.
Simply put, investors were ignoring the too-low price-to-earnings ratios, and instead focused on the trauma that airline stocks had induced in the past as they shifted in and out of bankruptcy. These carriers' financial position is so much stronger than in the past that AMR may well be the last industry bankruptcy we see for a very long time.
Just four months ago, I reiterated my ardor for Delta, and the carrier subsequently raised June quarter guidance in mid-June, thanks to falling jet fuel prices. But quite suddenly, Delta and its peers look a lot less enticing. This chart should tell you why.
A nearly $20 spike in crude oil in the past three months is bound to wreak havoc on profits in coming quarters, and you'll be hearing a lot more about it as the major carriers deliver second-quarter results over the next two weeks.
The Impact On Jet Fuel
Just a month ago, industry analysts had been using the current spot price of jet fuel (roughly $2.74) per gallon, and though there is a lag time between crude oil price moves and jet fuel prices, the price for jet fuel is now on the rise. According to the International Air Transport Association (IATA), jet fuel prices have risen 5.7% in the past month (to a recent $2.94 a gallon), and appear headed for $3 a gallon by the time the major carriers start to report results next week. Note that crude oil prices have risen more than 10% in the past month, so jet fuel has more room to move to adjust to the higher input price.
As long as crude oil prices remain above $100 a barrel, the airline industry will be dealing with higher jet fuel costs -- its largest expense after personnel -- which will make year-over-year profit comparisons challenged in coming quarters. That's not a concern for the second quarter, as the table below notes.
The real concern regards third-quarter forecasts as $3 jet fuel is bound to lead analysts to dial back their expectations. Compounding that concern, the economic troubles in China are leading to a slowdown in Asian travel, among both consumers and business travelers. That's an especially big concern for Delta and United Continental (UAL), which have a relatively larger presence in the Pacific travel market.
On a purely technical basis, the airline stocks already appear to be hitting resistance. A key airline index has made repeated runs toward the upper 50s and has failed to follow through. It's hard to know of the global economic turmoil (in emerging markets) or rising fuel prices, but it's clear that the mood has begun to shift.
Risks to Consider: As an upside risk, accelerating growth in the U.S. economy could offset air travel weakness elsewhere. Moreover, oil prices may cool off in coming weeks if China continues to give off signs of a slowing economy.
If you have profited from the great run in airline stocks, it's might be time to book profits. Yet this is a sector you need to keep monitoring. When investors shed their exposure to this industry, they tend to overdo it. Falling profit forecasts invariably lead to fresh concerns about industry balance sheets, though as noted earlier, those concerns are really misplaced. When the major carriers fall out of favor, compelling bargains are bound to re-emerge.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.