Airline Sector Making a Comeback

Lower capacity projections and renewed investor interest spur 10% rise since June

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Aug 22, 2018
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After a prolonged period in the doldrums since the sector’s precipitous drop in January, airline stocks are beginning to rebound. The boost has helped the Dow Jones Transportation Average set its first record since the beginning of the year.

After its 20% decline from its January high through late June, the NYSE Arca Airline Index has increased 10%. Shares of Southwest Airlines (LUV, Financial) have risen 14% in the past month alone; Delta Air Lines' (DAL, Financial) stock has increased 11%.

Rising airline shares have helped the S&P 500 gain over the past four trading sessions, resulting in a new intraday record. American Airlines Group Inc. (AAL, Financial) was the index’s second-best performer, rising 5.8%. American’s good fortunes lifted every airline stock in the index up approximately 3%.

Why the rebound?

Since its abrupt drop in January, the airline sector has had dramatically lower price-earnings ratios than companies in other sectors. A look at individual price-earnings ratios in comparison to the broader market index is instructive.

Airline Stocks Current Price-Earnings Ratios
American 7.53
Delta 9.24
United 9.46
Southwest 12.91
S&P 500 16.71
S&P 500 Technology Sector 18.66

A comparison of the relative price-earnings ratios of the tech sector and the airline group tells the tale. Increasingly more investors are looking to reduce their exposure, which for some has been inordinately weighted in the tech group. Is Netflix (NFLX, Financial) a bargain with a price-earnings ratio of 156?

Given the lower valuations in the airline sector and the increasingly positive outlook for the group, investors are looking to participate in a sector that has been undervalued relative to the tech and FANG stocks.

Another significant factor for the ascent of stocks in the airline sector is due to an overall lowering of projections for capacity growth. This is consequential because an increase in seats offered means the airlines are flying with too many unsold seats, hampering profits. Also, unforeseen and sudden expansion by competitors can lead to lower ticket prices. Airplanes flying with too many unsold seats are less profitable and quicker-than-expected expansion by operators can bring ticket prices lower.

Investor fears that increases in passenger capacity projections would lead to planes with empty seats hurt airline stocks prior to second-quarter earnings reports.

Other reasons for optimism for the sector include a drop in oil prices, which help airlines reduce costs. Although oil is still up 40% for the past year, crude prices have dropped 10% from a multiyear peak in June. Some analysts also think Saudi Arabia may increase supply, stabilizing oil prices, which would help airlines control a major cost component of operations.

Despite numerous signs of improvement, there are a number of metrics investors will be looking at in 2019. Analysts will be closely monitoring the continuing status of tariff negotiations and the impact that may have on the transportation industry. Additionally, although investors are pleased with the improving capacity numbers, they will be looking for share performance and future earnings projections before rendering a final verdict.

But for now, compared with the market as a whole and the overpriced tech sector, airlines look like a bargain.

Disclosure: I have no positions in any of the securities referenced in this article.