Low Oil Prices Bullish for Airline Stocks
What the heck is going on with the airline sector stocks, especially as oil prices continue to tank to their lowest levels since before the Great Recession? Generally, when oil prices drop, we see an upward move in airline stocks, but we are really not seeing this. So does that mean airline stocks are a great value or does that mean the demand for airline seats is low? My view is it could be a combination of the two.
Whether it’s West Texas Intermediate (WTI) or Brent crude, the reality is that oil prices are much lower than they have been in the past few years. WTI is at $36.00 and is showing technical signs of trending lower, towards $30.00 a barrel. We could even see a move to the $20.00 level if the world petroleum-producing countries continue to pump out crude at the same pace, despite the slack demand.
When the Organization of the Petroleum Exporting Countries (OPEC) decided to stay status quo on the production end, it sent the message that it was okay for oil prices to head lower. OPEC clearly wants the United States to continue cutting its rig count, while the Middle East oil cartel continues to pump out oil.
For the airline sector, the trend of lower oil is clearly a plus on the cost side. Yet we continue to see some of the airlines tack on a surcharge for fuel. Heck, this surcharge makes sense at more than $100.00 a barrel, but not at the $30.00 levels we’re seeing now. Call it greed or whatever; the airline sector is looking for added revenues. We see this strategy in some of the airlines charging extra for baggage or added legroom. Want a better view? It will cost you more. And if you want a snack or food, you’ll be lucky if you get a small bag of chips. On a United Airlines flight this summer, there was absolutely nothing but water.
For stock market investors, airlines charging more for these so-called extras is fine as long as travelers accept it, allowing the airlines to generate more revenues and profits to pass along to investors.
The problem, I see, is what if the muted price action in airline stocks is due more to the slackening demand? This would be problematic for the airlines and investors.
A good indication of the health of the airline sector will be the travel metrics in December. Any signs of lessening demand could suggest weakness ahead.
Red Flag Flying for Airlines
Take a look at low-cost carrier Southwest Airlines Co. (NYSE:LUV), which is $6.00 off its 52-week high. What’s concerning is that the airline warned to expect lower capacity growth this year and in 2016; this cannot be a good sign. In fact, Southwest cut its growth in capacity to between five and six percent in 2016, versus the prior seven percent. This could foreshadow a slowdown for the airline sector.
The wild cards will be the global economy, stocks, and jobs, of course. If these factors improve, there would be no reason to not expect a rally in airline stocks next year, especially if oil prices remain low.
How to Play a Bounce
In the discount airline segment, I like to watch JetBlue Airways Corporation (NASDAQ:JBLU), but the stock is currently more expensive on a relative basis versus the sector.
Three airline plays I feel could offer excellent upside if the sector moves higher include United Continental Holdings, Inc. (NYSE:UAL), American Airlines Group Inc. (NYSE:AAL), and Delta Air Lines, Inc. (NYSE:DAL). All three stocks trade at a price-to-earnings growth ratio of less than one and trade at less than one-times their sales. For a broad airlines sector play, take a look at the iShares Transportation Average ETF (NYSE:IYT).
Please note that these are not buy recommendations, but rather examples of airline stocks investors may want to take a second look at in the New Year.