Airlines are poised for a third year of stock gains even after a jump in jet-fuel prices.
Delta Air Lines Inc. and Alaska Air Group Inc. are projected to rise 20 percent or more this year, based on the average of analyst estimates compiled by Bloomberg. American Airlines Group Inc., Southwest Airlines Co. and United Continental Holdings Inc. are set for smaller gains.
The industry, which begins reporting earnings with Delta Thursday, is benefiting from stepped-up pricing power, steady economic growth and a boost from the U.S. tax overhaul. A recent increase in non-fuel costs is showing signs of slowing. Even the rise in oil prices won’t be all bad if it prompts airlines to rein in capacity expansion and focus on raising fares—which would be bad news for passengers but a boon for investors.
“We are optimistic about the 2018 outlook for the airlines as fares are trending higher due to rising fuel costs, and non-fuel unit cost growth seems to be reverting to historical levels,” Helane Becker, an analyst at Cowen & Co., said in a note to clients this week. “The airlines should benefit from the change in tax law.”
Since labor and fuel typically are airlines’ largest expenses, higher energy prices tend to make airlines more cautious about growth.
Carriers including American and Delta have slowed the expansion of flights and seats in recent years to let demand catch up with supply—and make it easier to charge more for tickets. Fare wars, which had dogged the industry for two years and flared up again last summer, abated in the second half of 2017.
Passenger revenue from each seat flown a mile, a benchmark gauge of pricing power, is likely to grow 2 percent to 3 percent for the foreseeable future, said Darryl Genovesi, a UBS Group AG analyst. Investors will get an update on the industry’s 2018 expectations when Delta, the No. 2 U.S. carrier, reports earnings and discusses its outlook Thursday.
“We continue to believe that the airlines’ stocks work when they are able to demonstrate pricing power,” Genovesi said.
There are still risks capable of denting or reversing potential stock gains. Labor costs have been rising as carriers have had to pay up to reach agreements with pilots, flight attendants and other work groups. Some airlines also face major airport renovations, new aircraft and technology updates.
“Many airlines really need to get their act together here,” Hunter Keay, a Wolfe Research analyst, said in a note last month to investors.
The S&P 500 Airlines Index, which includes the five largest U.S. carriers, rose 11 percent in 2017. While that was its second straight yearly increase, the advance trailed the 19 percent gain for the broader S&P 500 Index. This year through Tuesday, the airline gauge has slipped 2.4 percent while the S&P has climbed 2.9 percent.
Carriers also have relatively low stock valuations. Airline share prices are only 12 times earnings, according to the industry index. The S&P 500 average is 23. Railroads get 25.
That’s been a sore spot for airline bosses such as American’s Doug Parker and Delta’s Ed Bastian. But they still need to show that their companies, with their history of bankruptcies and boom-bust cycles, can withstand economic downturns and increases in fuel costs. With benchmark U.S. oil prices at a three-year high, investors will be watching closely at the impact on profits.
An added boost is likely from U.S. tax changes. Southwest, the only U.S. taxpayer among the four largest carriers, already has said it will invest savings from lower tax rates, in part by purchasing planes, hiring workers and boosting benefits for current employees.
Airlines that aren’t currently paying taxes will win, too. American, Delta and United don’t pay cash federal taxes because of billions of dollars in past operating losses that they use to offset taxable income. However, they will see an immediate boost to their per-share earnings because those earnings reflect “book” tax rates, even if the airlines don’t currently pay cash, Raymond James Financial analyst Savanthi Syth said.