The world is looking at the threat of another volcano eruption, this time from the ominously-sounding Grimsvotn. Iceland shut down local airports near Reykjavik and grounded many international flights. This volcano brings some notion of deja vu, after the Eyjafjallajokull eruption last year that left 10 million travelers stranded and blanketed the entire island, as well as parts of Europe, with ash.
The major airlines appear to be unable to catch a break. They have worked hard at shedding seat capacity to better match passenger demand. Have you noticed that every flight you’ve been on has been packed to the brim? The US majors aren't driving pricing anymore in many markets; instead, the low-cost "no frills" carriers do. The majors are left to compete in an industry where they are without leverage on the cost side as well as on the revenue side. The Earth's terra firma isn't helping. And in an era of continually higher energy prices, many strapped consumers are simply going to be priced out of the domestic and international air travel markets.
Here are the airline stocks that will be affected as passengers, often incorrectly, presume this volcano is like its 2010 predecessor.
United Continental (UAL): United merged with Continental, and the company will face a tough job continuing to integrate the two. Competitors, both established and new, as well as significant fuel price increases will hamper this company. Although UAL can grow revenues with higher ticket prices, it hasn’t been able to narrow the cost differential that exists with low-cost airlines like Southwest (LUV). United does have flights in and out of Iceland, and many of those will be affected by this event.
We do expect mid-margin expansion due to synergies, albeit at half the $1 billion figure offered by management. We still value shares at $23 apiece, using a 12% discount rate.
Delta Air Lines (DAL) still appears set to begin service to Reykjavik on June 1. We expect a tepid response for tickets. We were puzzled by Delta's announcement to introduce non-stop service from New York City to Reykjavik. Management should consider this event to be a cautionary tale.
Delta should be able to grow revenues at a 7% clip and keep margins around 6%. The monster of fuel prices will hamper any real growth for the company, along with its high debt load and large number of ancient, fuel-inefficient aircraft. Periodic battles for market share with other established and newer players in the industry will keep a lid on Delta. We value shares at $10 apiece, using a 12% discount rate.
LUV: Despite a successful hedging program in the past, Southwest is likely to be hampered by fuel costs and poor service going forward. The airline completed its acquisition of Airtran on May 2. We think this acquisition will be accreditive and that Southwest paid a reasonable price.
At Southwest, peaked schedules with close connection times makes for tough operations. The proof is in the data: It is now last in on-time departures. At 30% of expenses, fuel -- coupled to an 80% share of unionized workers -- should cost Southwest its ability to produce a return on invested capital in excess of its cost of capital. Shares are worth $11 apiece, using a 12% discount rate. LUV has no real relationship with Iceland; however, we still think investors may be spooked by the sector.
US Airways Group (LCC) should be able to grow revenue in the mid-single digits, and cost-cutting should produce margins of 4-5% over the next few years. Again, fuel costs, already above 20% of expenses, will likely compress margins and deplete the impact of cost-cutting measures.
US Airways Europe destinations could be negatively affected by ash from Grimsvotn. Investors are reminded of last year, when some of US Airways' international passengers were stuck in Europe. US Airways had to take care of them.
The expansion in Europe, South America and Asia continues to spread the costs thin. Also, 90% of company workers are unionized and will create a substantial burden on the company’s ability to return any cash to shareholders. Shares are worth $8 apiece, using a 12% discount rate.
JetBlue (JBLU) benefits from its smaller size, at least with respect to the latest Icelandic volcano. This national carrier should be able to control fuel costs better than its peers and increase revenues from complementary services to passengers. Sudden changes in fuel prices will still cramp future earnings and cash flow to the company.
JetBlue faces extra risks not borne by other airlines due to its thin expansion into new markets. It also faces the prospect of full-scale unionization of employees. We value shares at $3.00 apiece, given its high debt-to-capital ratio around 2:2. JetBlue's venture with Lufthansa (DLAKF.PK) will almost certainly be affected by the latest volcano.
AMR Corporation (AMR): American Airlines faces fuel costs accounting for 25-30% of its operating budget. Most of its Stateside employees are unionized and locked into two-year contracts, which tends to result in wage spikes at each interim. New members in the airline industry peel away valuable revenues to AMR. The poor performance and the firm's higher labor costs are a result of AMR's skipping around bankruptcy in the past decade, while others washed away costs during the process. The company’s pension plan is also underfunded. Shares are worth $7 apiece. We assume 5.5% margins.
AMR has significant exposure to volcanic ash through its European destinations. Investors are reminded of last year, when some of AMR's international passengers were stuck in Europe. AMR had to take care of them at a not insignificant cost to the bottom line.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.