Yield Outlook Deteriorates for Airline Stocks

by: Valuentum

As we had outlined in our industry primer for airlines, the yield (pricing) environment for the group is treacherous and remains under perpetual pressure. The International Air Transport Association [IATA] released its July 2011 Airline Business Confidence Survey. Importantly, the IATA commented on the outlook for yields, which we reproduce below:

While both passenger and cargo transport businesses saw improving yield performance during the second quarter of 2011, the trend is flattening. With demand-supply conditions weakening and concerns that markets may not bear further fare/rate rises, prospects for yields over the year ahead look flat. With over 80% of respondents reporting increased input costs during Q2, clearly high fuel costs have impacted financial performance. However, while cost pressures will persist, expectations of large further increases over the year ahead have moderated considerably. Source: IATA

We view this as a red flag for a group that must raise prices and layer on extra fees in order to offset the rising price of crude and hold the line with profitability. In the report, the IATA also noted the potential for increased capacity to enter the system and reiterated that the "scope for further yield increases is reducing." The IATA also indicated the following:

...load factors are down on their 2010 peaks and, with demand-supply conditions weakening, prospects for significant further yield increases are waning. Just over 68% of respondents reported passenger yield increases in Q2 2011 – down from the 75% in April. Overall, on a weighted average basis, the score for yield performance over the last quarter was 73.7 – turning to point back in the direction of the 50 ‘no change’ mark for the first time since recovery began in late 2009. Source: IATA

Overall, such a report is a material negative for the group and specifically for the majors: AMR (AMR), US Airways (LCC), United Continental (NYSE:UAL), and Delta (NYSE:DAL), which have to compete with low-cost peers--like Southwest (NYSE:LUV)--which may not follow along with fare price increases. As we have outlined in our Best Ideas Newsletter, we continue to hold put options on AMR and the Guggenheim Airline ETF (NYSEARCA:FAA), which we believe to be adequate to gain exposure to the expected decline in airline market values, which has taken hold. SkyWest (NASDAQ:SKYW) is off almost 15% on a poor outlook, while the rest of the group is trading down between 4%-6%. In all, we maintain our bearish view on the airlines.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.