Is the Airline Industry Good for Investing?
Erin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Depending on which airlines you choose to focus on, the airline industry either looks great or difficult. The second quarter results from the larger U.S. carriers provide a mixed bag of results that should cause investors to think twice. Both the overall business model of the industry and fuel costs prevent the airlines from considerable long-term financial strength.
Dallas-based Southwest Airlines (NYSE: LUV) notched a 42% increase in second-quarter profits. US Airways (NYSE: LCC) is smiling over its “highest quarterly profit in company history,” with a $306 million total. JetBlue Airways (NASDAQ: JBLU) enjoyed an 11% revenue increase for a 16% share improvement (over 8 cents a year earlier).
Meanwhile, United Continental (NYSE: UAL) saw its net income drop 37% in the second quarter. The company earned $339 million for the quarter (89 cents per share). Excluding special items, it would have earned $545 million ($1.41 per share). Earnings are down from the year earlier's results of $538 million ($1.39 per share). The company attributes its lack of profitability to merger difficulties.
Delta Airlines (NYSE: DAL) is not faring well either. The company lost $168 million (20 cents per share), in the second quarter. The airline lost $561 million in fuel hedges. If not for fuel prices, Delta would have earned $586 million for the quarter (69 cents per share).
"We are producing very strong results despite a fragile economic environment," said Southwest Airlines' Chief Executive Gary Kelly in a statement.
US Airways CEO Doug Parker said, "Consumer demand for our product remained strong during the second quarter, resulting in record revenue, passenger yields, and unit revenue performance.”
Overall, the airline industry has enjoyed improved numbers. On the surface it would appear to be a good time to invest. However, airlines are not a safe investment, nor are they likely to be anytime soon.
Historically, the airline industry has been quite volatile. Airlines merge, go bankrupt, take over each other, downsize, etc. with such frequency that at times it can be hard to remember which airline currently owns which. US Airways is in the process of taking over bankrupt American Airlines right now. Southwest Airlines acquired AirTran Airway in 2011. United Airlines bought rival Continental in a $3.17 billion all-stock deal in 2010. The new company is now the world's largest air carrier but has struggled with integration details from the merger. Much of the company's expenses in the second quarter were due to costs related to the merger, including systems integration and training, severance packages for voluntary retirements and employee relocation.
The volatility and constant instability of the airlines is just one reason to avoid investing heavily in the industry. One other major reason to give pause before investing is fuel prices. Only Delta reported a loss this quarter due to fuel hedges, but it was not the only company affected. Southwest registered a profit, but it also took a loss on fuel hedges. US Airways admitted in a statement, “we anticipate fuel expenses for the airline to rise marginally from the year-ago period.” JetBlue lost about $1 million in fuel hedges.
It is no secret that all of the airlines have a fuel problem, and that problem is the customer's problem. The airline business model is designed to pass along increased fuel costs to customers. However, it is a competitive industry, and consumers have options on which airline to fly. Higher prices mean reluctant customers. Airlines hiked fares 10-12 times in 2011, and in February 2012, JetBlue, United, Delta, American and US Airways all raised ticket prices again.
Airlines passed $22.6 billion in ancillary fees on to passengers in 2011. Checked bag fees and ticket change fees added up to more than airlines’ total operating profit in several recent quarters, suggesting that the airlines may not have otherwise been profitable. United Continental brought in $3.4 billion in revenue, while Delta charged $1.6 billion to passengers. American Airlines, currently in bankruptcy, raised $1.4 billion in fees.
Southwest Airlines uses a different business model from the rest of the industry. Southwest prices out tickets in advance, based on projected fuel costs in the future. By doing so, it has been able to avoid raising prices on passengers when other airlines have to. If fuel prices rise, the company takes the hit, not the passengers. This model has both worked well for Southwest and caused it to take losses in the past. The company also touts a "bags fly free" perk. Even so, the company earned $766 million in ancillary fees.
Ironically, it appears to be Delta who is best suited to beat the difficulties of unpredictable fuel costs. The company has purchased its own refinery in an attempt to lessen the impact of fluctuating oil and petroleum costs. Delta purchased the refinery for $150 million and estimates it will save the company close to 2.5% on fuel expenses ($300 million). At first, 2.5% may not seem like enough of a savings to warrant such an undertaking, but compared to the $561 million lost in fuel hedges in the last quarter, the $150 million expense seems rather reasonable.
The second quarter results from the larger U.S. carriers are a prime example of the unpredictable volatility of the airline industry. Even the companies that are doing well are still seeing losses in the same areas. Both the overall business model of the industry and fuel costs prevent the airlines from considerable long-term financial strength. Investors looking at the airline industry must look at the overall picture, and not just recent successes and failures.
ErinAnnie has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Southwest Airlines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.