- Higher fuel costs threaten airlines' efforts to return to profitability
- Many carriers are responding to this challenge by cutting their seat capacities and hiking ticket prices
- Airline stocks don't make a compelling investment case in the current uncertain macro environment
As US airlines start to report first quarter earnings this week, investors will be keen to learn if the swelling demand for leisure travel after the pandemic-driven slump has been enough to improve profitability.
Just as air travel started to rebound after the rapid spread of the Omicron variant last winter, rising fuel costs and recession risks dampened the sector's growth outlook. During the past three months, the U.S. Global Jets ETF (NYSE:JETS) lost almost 7%, giving up earlier gains made this year. It closed on Monday at $20.39.
Amid increasing global energy constraints due to Russia's invasion of Ukraine, airlines are now projecting jet fuel to range between $2.80 and $3 a gallon this quarter, up from previous estimates of around $2.50. Jet fuel makes up about 20% to 25% of airlines' annual operating expenses.
These figures could potentially derail efforts from most airlines to return to profitability after the collapse in travel during the coronavirus pandemic.
However, some airlines remain optimistic. Their short-term weapon is to cut seat capacity, thus increasing ticket prices.
Several of the largest carriers, including United Airlines (NASDAQ:UAL) and American Airlines (NASDAQ:AAL), have cut their capacity forecasts for the first quarter, while Delta Airlines (NYSE:DAL) held growth to the low end of a previous range, according to their regulatory filings. These airlines also boosted their revenue expectations, citing surging travel demand from waning coronavirus infections.
While airlines could raise fares by reducing the number of seats available, they have to be very careful, as consumers face inflation threats, now at the highest level in 40 years.
MKM Partners, in a recent report, said:
"We do not expect airlines to reduce capacity significantly, so expect tweaks and not cuts, which ultimately means overcoming higher fuel with the price is unlikely."
Big Picture
Encouraging air traffic trends can't hide that airline shares have been a poor investment for several years now. For instance, the JETS ETF lost more than a quarter of its value during the past five years, while the S&P 500 almost doubled.
Furthermore, even if leisure traffic continues to rebound, there is only a slim chance the business travel segment—the most profitable for airlines—will return to pre-COVID levels soon.
Analysts are not excited about airline stocks. Bank of America said travel demand should outpace supply, particularly during peak leisure times. Still, it will not create enough pricing power for airlines to offset higher fuel costs.
Delta To Report A Loss
Kick-starting the industry's earnings season Wednesday, analysts expect Delta Airlines to report a per-share loss of $1.33, about half of the same period a year ago. Sales are likely to jump to $8.74 billion, more than double when compared with the same period in 2021. The stock closed Monday at $38.21.
According to analysts' consensus forecasts, American Airlines, which reports earnings on Thursday, Apr. 21, may also see its per share loss shrink to $2.44 while sales surge to $8.63 billion. AAL closed Monday at $16.97.
Bottom Line
The next stage of growth for airlines, which will depend on business travel, still contains many uncertainties, including geopolitical conflicts and risks to global growth amid higher interest rates. In addition, businesses are unlikely to resume worker travel when inflation is surging, and managers are looking to cut costs.