Airlines Soar Despite High Fares

Includes: AAL, DAL, LUV, UAL
by: Zacks Investment Research

Jet fuel prices rose over 53% as oil prices increased to above $100 per barrel, given the ongoing civil unrest in the Middle East. Despite the sharp rise in fuel prices, airline traffic picked up significantly in February, attributable to a strong revival in the economy. The month also saw improved performances on the heels of increased air fares and higher revenues collected from extra fees.

Airline traffic is measured in billions of revenue passenger miles (RPM), which means one mile flown by one passenger.

The carriers are benefiting from strong travel demand, industry consolidation, substantial improvement in yields and better capacity management, which resulted in enhanced supply-demand conditions.

Further, it is estimated that U.S. carriers will be able to combat 65-70% of the increase in energy costs with higher revenues in 2011 and 2012. These have already undergone the sixth round of broad-based price increase this year. Many major airlines increased their ticket costs by as much as 30% since the beginning of the year.

International traffic increased at United Continental Holdings Inc. (NYSE:UAL), the largest U.S. airline. But this growth was offset by a decline in domestic traffic, resulting in a modest 1.1% year-over-year decrease in the company’s February traffic.

Capacity (or available seat miles) grew 1.8% year over year and load factor (percentage of seats filled with passengers) fell 230 basis points (bps) year over year. The company expects 10.5% to 11.5% year-over-year increase in unit revenue for February, measured by passenger revenue per available seat mile (PRASM), a key metric in airlines.

The Zacks Consensus projects a loss of 24 cents for the first quarter of 2011, representing an improvement from a loss of 55 cents in the year-ago quarter. We believe that growing demand for air travel, a revival in the airline industry, tight capacity, industry leading unit revenue growth, fleet right-sizing, network optimization, hedging strategy as well as the merger benefits from Continental Airlines bode well for United Continental’s future growth.

Delta Air Lines (NYSE:DAL), the second-largest U.S. airline, reported a 1.4% year over year traffic increase in February on 6.1% capacity growth partially offset by 340 bps decline in load factor. Domestic traffic dipped 0.2% year over year due to a capacity increase of 1.9%, offset by a decline of 170 bps in the load factor to 77.1%. International traffic increased 4% year over year primarily driven by a 12.5% capacity increase while load factor decreased 560 bps to 68.8%.

The Zacks Consensus projects a loss of 18 cents for the first quarter compared with a loss of 23 cents in the year-ago quarter. This represents a significant growth of 21.3% year over year. We remain cautious about Delta’s balance sheet, which has a high debt level compared with its peers and historical levels. Delta Air Lines stated that its top priority is debt reduction. To that end, net debt is expected to decrease to $10 billion by 2012 from $15 billion at the end of 2010.

The low-cost carrier Southwest Airlines Co. (NYSE:LUV) recorded a 13% year-over-year rise in February traffic on a capacity increase of 8.6%. The month’s RPM increased to 5.6 billion from 5 billion in February 2010. Load factor grew to 76.9% from the year-ago level of 73.9%. The company expects PRASM to increase 8% to 9% year over year for February 2011.

Our current Zacks Consensus Estimate for Southwest Airlines is 2 cents for the first quarter compared with 3 cents in the year-ago quarter. If the company meets the Zacks Consensus Estimate, it would result in a substantial decline of 39.39%. We foresee a decline in first-quarter earnings due to escalating fuel prices that might adversely affect the ongoing recovery in the airline industry.

On the other hand, we believe Southwest Airlines is well positioned for growth due to its cost leadership position, strong balance sheet, low cost, flexibility, network optimization and increasing revenue initiatives such as new frequent flyer program and the induction of Boeing 737-800 fleet into its network. Southwest Airlines’ acquisition of AirTran Holdings (AAI), scheduled this year, should also augur well.

February traffic for AirTran Airways, a subsidiary of AirTran Holdings, grew 2.7% year over year to more than 1.3 billion in February on a capacity increase of 0.3%. Load factor expanded 180 bps to 76.9% from the year-ago quarter.

American Airlines, a wholly-owned subsidiary of AMR Corporation (AMR), reported a traffic increase of 2.2% year over year on capacity increase of 3.1% partly offset by a 70-basis point decline in load factor. Domestic traffic was flat year over year due to a 0.2% rise in capacity and international traffic climbed 6% on a capacity increase of 8.5%.

Traffic rose 4.5% to 4.17 billion RPM for US Airways Group Inc. (LCC) in the month under review. Capacity increased 5.6% and load factor dropped 90 bps year over year to 76.3%.

Currently, we maintain our long-term Neutral ratings on Southwest Airlines, Delta Airlines and United Continental Holdings. For the short term (1–3 months), Delta Airlines and United Continental Holdings retain a Sell rating with a Zacks #4 Rank and Southwest Airlines has a Strong Sell rating with a Zacks #5 Rank.