Airline stocks have been flying high in 2023, rebounding from the dismal Covid years. Strong second-quarter reports from Delta Air Lines, United Airlines and American Airlines confirmed that air travel demand is returning to pre-pandemic levels.
So far this year, the number of people traveling by airplane is on par with 2019 traffic, according to Transportation Security Administration data. As people returned to the skies, airline stocks and a number of other travel issues took off late in the first quarter. Now that rally faces a number of hurdles, including a possible strike at American Airlines, an increase in fuel costs and possible profit-taking by investors.
Third Bridge analyst Christopher Raite told IBD this week that several key factors contribute to the current state of the airline industry.
"A significant driver is the strong demand that has emerged following a period of uncertainty spanning three years," Raite said.
Consumers' bank accounts have fallen from pandemic-era highs but still remain 10%-15% higher than pre-pandemic levels, according to Raite. The analyst said savings are recently being spent on international travel.
Raite added that at the beginning of 2023, major carriers, including American Airlines, were operating with 5%-10% less capacity vs. the same period in 2019.
"Less capacity with higher demand leads to higher prices," Raite said.
However, in the second quarter this dynamic is beginning to ease, presenting another challenge. As capacity starts to surpass 2019 levels, it could erode airline pricing power in the second half of 2023, Raite said.
The Bull And Bear Case For Airline Stocks
On July 18, Morgan Stanley analyst Ravi Shanker's bull case for airline stocks projected a "new 'golden age' of travel."
Under this scenario, Morgan Stanley sees leisure travel demand continuing unabated and "well in excess of 2019 levels," while international and business travel fully recover.
American Airlines reported on Thursday that fuel prices have averaged $2.94 per gallon in the first half of the year, down around 15% compared with 2022.
Meanwhile, in Morgan Stanley's bear-case scenario, inflation and interest rates pressure consumer discretionary spending. In this case, airline stocks decline as oil prices rise and capacity constraints ease, "driving competition, and/or regulatory risk around pricing."
Airline Stocks Pause After Delta Earnings
On July 13, Delta Air Lines kicked off earnings season, reporting that Q2 profits surged more than 80% on a 20% sales jump as consumers' appetite for international and domestic air travel appears to be strong.
The Atlanta-based carrier saw international and domestic sales jumping 61% and 8%, respectively. Delta Chief Executive Ed Bastian declared "consumer demand for air travel remains robust."
Bastian added that the company is increasing its 2023 earnings guidance to $6-$7 per share and reiterated its recently updated outlook for $3 billion of free cash flow. Wall Street forecasts Delta 2023 EPS jumping 110% to $6.72, according to FactSet.
Despite the strong financial performance, Delta shares dropped nearly 3% for the week as investors took profits after the earnings report. That marked the stock's first decline in nine weeks. Collectively, the 19 stocks in IBD's Transportation-Airline industry group also slipped for the week — for only the second time in nine weeks.
That may have been just a brief pause in the overall industry rally, as the group gained more than 2% for the week. The airline stocks industry group has rallied around 41% so far in 2023, pulled back from a 56% gain through July 13. That's the 16th best increase among the 197 industries tracked by IBD.
Airline Stocks Surge In 2023
As of Tuesday, Delta is up around 41%. American Airlines stock has gained 31% since the end of 2022 while United Airlines has advanced 44%. All are pulled back from highs.
Copa, the leading Latin American air carrier, is also on the upswing, gaining 42% so far in 2023. Domestic-focused Alaska Air Group cut a 25% to 12%. The U.S. Global Jets ETF is up 23% so far in 2023, after falling 19% in 2021.
Meanwhile, Southwest Airlines has increased 6%, while Spirit Airlines shares have fallen around 4%.
United Airlines, American See Profits Surge
Last week, American Airlines and United followed Delta, reporting better-than-expected second-quarter financials.
On Thursday, American Airlines announced profits growing more than 150% and raised its full-year earnings guidance, buoyed by strong demand for air travel and lower jet fuel prices. On Wednesday, United Airlines reported EPS skyrocketing more than 250%.
American Airlines also raised its full-year earnings guidance to $3.00-$3.75 per share, up from the previous forecast of $2.50-$3.50. The company added that it expects Q3 EPS of 85 cents to 95 cents. AAL said this guidance is based on current demand trends and fuel price forecasts.
Analysts predict full-year profits ballooning 526% to $3.13 per share, according to FactSet.
Meanwhile, United forecast Q3 earnings at $3.85-$4.35 a share. FactSet analysts project $3.79. For the full year, United management guided expectations for adjusted profit to $11-$12. FactSet consensus sees $10 per share.
The Risks With Airline Stocks
Some things are out of anyone's control. The coronavirus pandemic, for example, brought global air travel to a halt.
Then, toward the end of 2022, the airline industry was just a fragment of the U.S. economy. Airlines were upended by freezing temperatures, high winds and snowfall from a massive winter storm that blanketed more than half of the U.S.
The storm forced much of the U.S. airline network to shut down. Most carriers recovered normal operations within days. But Southwest Airlines lagged far behind the rest of the airline industry, attempting to recover from weather disruptions that resulted in thousands of canceled flights.
In January, following December's air travel fiasco, the Federal Aviation Administration also grounded thousands of flights across the U.S. for several hours after a key computer system failed. However airline stocks showed only a mild response.
Other factors are as fickle as the weather. The dwindling bank accounts of consumers could run up against industry capacity-driven price increases, leading to a drop in demand. Additional interest-rate hikes expected from the Federal Reserve will drive up mortgage and credit-card costs for consumers, and capital costs for airlines.
The price of fuel presents an even greater threat. If oil demand continues to recover, industry watchers project a sharp uptick in oil prices. For airlines, which generally assess fuel at 20% to 30% of their total expenses, that could represent a significant drop in earnings.
Staffing Issues A 'Risk' For Air Carriers
Meanwhile, Raite sees labor-related concerns as the "most significant risk" for airline stocks.
Raite told IBD that for more than 10 years the airline industry has grappled with a looming pilot shortage, which "manifested itself during the pandemic."
On July 15, ahead of earnings, United Airlines pilots announced they reached a tentative agreement with the company on a new labor contract after more than four years of negotiations.
The proposed contract is valued at around $10 billion and would increase pay up to 40% over four years, according to the New York Times.
Delta Air Lines approved a pilot contract in March that included a 34% increase in pay raises over the life of the contract.
"These combined factors have led to unprecedented levels of pilot compensation," Raite said.
Pilots at Southwest Airlines in May approved a strike that is now pending. Flight attendants at American Airlines are set to vote over the next month to authorize a possible strike.
While Raite sees staffing impacting airlines directly, he believes it is more of an issue for airline suppliers, such as Boeing and Spirit AeroSystems.
"Insufficiently skilled and understaffed teams have played a substantial role in the recent surge of delays and cancellations, particularly during holiday weekends," Raite said.
Please follow Kit Norton on Twitter @KitNorton for more coverage.
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