Tuesday, June 17, 2014
Is the Party Over for Airline Stocks?
It has been wild week on the market, with Apple stock splitting 7 to 1, a new crisis in Iraq and spiking oil prices. If that is not enough Europe now appears to be thinking about raising interest rates before the year is out. The culmination of these events resulted in a triple digit sell off on Wednesday and Thursday. Now this particular blog could be on any number of those topics, I could go into detail on how our President refuses to deal with the crisis with the Al Qaeda in Iraq. I am not going to do that though, instead I will address the selloff that occurred in an industry I have been bullish on for over a year, the Airlines.
For people who have been following airline stocks recently you know that the industry is in the middle of one of the greatest turn round’s in business history. Airline stocks were amongst the best performers last year, impressive considering that last year was a record breaking year for stocks.
The airlines are recovering from the chaos of the 1990’s and early 2000’s where almost every major airline in the U.S went bankrupt, including former industry leaders like Pan Am and TWA. Since then airlines have begun to consolidate, with the smaller weaker companies going out of business and the larger somewhat stronger companies merging out of necessity.
The effect of this consolidation is the U.S Airline industry being controlled by just 3 or 4 large players, American Airlines (just fresh off its merger with U.S Airways last year), United (also a product of a merger with Continental in 2010, Delta Airlines (in my opinion the strongest airline and also created when Delta bought Northwest airlines), and to a lesser degree Southwest Airlines.
This consolidation in the airline industry has led to higher prices for airfare which means higher margins which adds up to higher profits and stability which has not been seen in the industry since its deregulation in the 70’s. Under these new conditions the airlines have flourished and have rewarded shareholders handsomely.
Now that you have some background on the industry the question is, why am I writing this? The answer is that the airlines have fallen victim to a large and in my opinion somewhat unwarranted sell off this week. Yes airline stocks that have gained over 50% in the last 6 months fell upwards of 5-7% last week. Ok I am lying the selloff was not entirely unwarranted. On Wednesday the primary German Carrier, Lufthansa, announced an earnings warning saying that profits for 2014 might be as much as 33% lower.
Wait lets step back a moment, I thought that the Airlines were flourishing? In fact European airlines are facing significant challenges (As was highlighted by Lufthansa). The German airline, with a market cap of over $12 billion, stated that increased competition from Gulf Carriers, labor union strikes, adverse currency effects, and unexpectedly weak revenue growth in its passenger and cargo businesses, all contributed to Lufthansa’s troubles.
After the warning came out shares of Lufthansa fell 15% (understandable considering shareholders have just found out that the airline is expected to make just $1.35 billion for 2014, instead of the previously estimated $2 billion) Unfortunately for the rest of Europe’s Airlines the concerns stated by Lufthansa also pose a problem for the rest of them. Shares of International Consolidated Airlines Group (parent company of British Airways) and Air France immediately headed lower as there German counterpart announced that competition from low fare airlines and larger competitors in the Gulf was cutting into margins.
Oh no, this is exactly what destroyed the Airlines before, extreme competition and price wars coupled with union labor troubles. Apparently Europe’s Airline industry is going through what the U.S based industry went through during the late 20th century. Normally I would not really care about what Europe’s airlines had to go through, since I am mostly invested in American airlines (specifically Delta, Southwest and Spirit) but the sell-off of European airline stocks quickly spread to the U.S. Major carriers in the U.S were all down on Wednesday. But Lufthansa was the least of the airlines worriers this week.
While Wednesday’s sell off was a healthy breather for U.S airline stocks Thursdays sell off was far more detrimental. Apparently an Al Qaeda splinter group had taken control of Northern Iraq, including Iraq’s second largest city. This caused the price of oil to skyrocket to a 9 month high of $107 a barrel. To the airlines, whose very survival hangs on the price of jet fuel, this rise in oil prices caused a major sell-off, with shares of all major airlines down over 3-7%.
So with increased competition in Europe, and rising oil prices is the party over for airline stocks? The answer is no! Competition in Europe does not really affect the American based airlines, and the rise in the price of oil was unwarranted and will fall during the next few months.
The unwarranted rise in oil prices was due to commodity traders being worried that the flow of Iraqi oil will be interrupted by the insurgents in Northern Iraq. What these traders did not take into account was that the majority of Iraqi oil comes from the South, nowhere near the fighting. Even if the fighting does interfere with oil production Iraqi oil is no longer as much of a factor to the U.S market. The U.S now produces enough oil to meet its own demand and lobbyists from major oil companies are even now trying to have Congress pass an act allowing the U.S to export some of its oil.
With U.S shale oil deposits producing so much oil U.S airlines are in a much better position to get there vital jet fuel then there European counter parts. Another point as to why the Airlines have been oversold and why Airline stocks will continue their march upwards is that many airline stocks are still very cheap.
Delta airlines for example, the airline has a P/E of just 3.4, that’s amazingly cheap considering the S&P has an average P/E of 16. Delta airlines is probably the most attractive airline stock out there but other airlines like Southwest are also attractive, considering that Southwest does not even fly to Europe and so avoids the conundrum confronting the Airlines in Europe completely.
To conclude this week’s sell off in the airline offers nothing but opportunity, as the market begins to correct itself after the sell off last week the airlines will regain their momentum. This sell-off provides the first opportunity to buy airline stock in a long while; I would take advantage of it.
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