If new security concerns dampen airline revenue only .25–.50 percent, the result is a 10–20 percent hit to airline earnings and share prices, all else held constant and based on our base-case scenario for 2010.
Smart airline investors pull the “sell” trigger quickly when any new risk factor materializes that could impact earnings. We make the case that this is the proper response when investing in the over-leveraged and high [systemic and operating]-risk airline sector.
It is reasonable to believe that enhanced security measures will result in a small percentage demand drop-off as business and international travelers, and the well-heeled, seek alternatives and substitutes to the time-killing commercial airlines. In other words, increased “security” increases the travel hassle factor, which in turn results in a drop-off in high-yield traffic. Private corporate jet travel and Internet meetings [conference calls] become more attractive to airline passengers as more time is wasted waiting in security lines and freedoms aboard the aircraft are restricted.
Any drop-off in demand is likely to be temporary and minor, but the risk aversion to airline shares likely has longer legs as it is reasonable to expect other terrorist attempts in the future. Moreover, enhanced security will result in higher costs [lower earnings] for the airlines. Given the more than $3 billion gap between what it costs for aviation security – $5.2 billion in 2008 – and the fees collected from the aviation community, it also is reasonable to expect that the government will want to shift more of the costs of security to the airline industry.
Disclosure: Westjet shares