Airline Industry Overview

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Stocks in the air transport sector can certainly be rewarding during a period of rising gross domestic product and employment, along with stable or falling fuel prices. Indeed, a well-timed investment could outperform the broader market significantly. Of course, these equities carry substantial risks, as well, including high levels of debt on their balance sheets and volatile energy costs. The latest rebound among several of the legacy carriers’ shares has brought them some renewed attention. If you are considering an investment, here are some aspects of the industry that one should be aware. That is not to say each passenger airline is alike; they often pursue differed strategies be it targeting cost containment or expansion and growth.

A couple of the events of late that have lured investors include pending mergers and the finalization of a pilots’ contract by industry leader United Continental (NYSE: UAL). Notably, another major, AMR Corp., had excessive labor costs, and is currently operating in Chapter 11 bankruptcy.

The effect of global economic conditions on industry profitability can be broken down to several external factors. For one, a pickup in discretionary spending tends to lift consumer travel expenditures. Furthermore, when business activity is rising, corporate flying increases, allowing for both increased aircraft utilization and higher airfares. In fact, fare hikes / cuts are key to a particular carrier’s fortunes as margins can fluctuate greatly. On that note, revenues-per-available-seat-mile, a measure of yield, is closely watched by airline management. So, improving macroeconomic conditions, such as falling unemployment, can have a considerable impact on results.

Crude oil and jet fuel prices have been relatively stable in 2011 and 2012, allowing airlines to focus on profit enhancements. Certainly, they can be susceptible to rising fuel costs, and most carriers now hedge a considerable percentage of their expected fuel requirements. Southwest Airlines (NYSE: LUV), for instance, has historically reaped gains from fuel price hedging. As the industry’s biggest cost, fuel expenses significantly affect stock prices. Carriers aim to keep these and labor costs in check, while targeting revenue gains.

Disparate strategies can indicate the reasons for different earnings trends among airlines. While the larger entities are mostly looking to adjust capacity to match demand, some smaller airlines are taking share on domestic routes through aggressive expansions. The majors may add flights in markets where they can realize strong yields, be it in the U.S. or internationally. Meantime, for example, JetBlue Airways (NASDAQ: JBLU) has plans to continue to build its fleet and increase its presence in markets such as Boston.

Numerous airlines remain burdened by massive long-term debt balances having suffered through periods of red ink. As such, high interest costs and debt obligations may limit profitability and their abilities to fund fleet purchases. Nevertheless, efficiency overall has ascended, as evidenced by climbing load factors industrywide (occupancy rates) over the past several years, thus allaying the risk of incurring large losses.

UAL shares could prove a good pick for long-term focused, risk-tolerant investors, as it is perhaps the carrier most aiming to restrain capacity and improve productivity. Plus, it is in the process of integrating the Continental acquisition. US Airways is intriguing due to the chance that it may merge with American. Numerous others, including Delta Air Lines, Southwest, JetBlue, and Alaska Air Group might provide nice returns given favorable industry conditions.          


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