Rising jet fuel prices could reflect optimism that travel demand will pick up later this year.
Spencer Platt/Getty ImagesAirline stocks should be falling with oil prices on the rise. But the sector appears to be taking a cue from the commodities market, betting that higher fuel prices are a bullish signal for demand.
Jet fuel prices have surged since early November, tracking gains in the price of crude oil. A gallon of jet fuel cost $1.13 back then; the spot price is now $1.68, including a 14% gain in the past month.
Fuel is the largest variable cost for airlines. And companies aren’t in a great spot to absorb it. Many flights are operating well below their seating capacity with passenger “load factors” under 75%. Airlines are mainly selling economy-class leisure fares as business travel remains depressed.
The dynamics are pressuring airlines’ unit economics. Low load factors and average fares are keeping revenue yields per flight depressed. Cost per average seat mile could be on the rise if jet fuel prices increase further.
Yet investors don’t appear concerned—in fact, quite the opposite. The NYSE Arca Airline Index has surged 70% since early November, coinciding with the ascent in oil prices. The index was ahead 2% on Wednesday and is up 16% for the year, beating the S&P 500′ s 4.6% gain.
The stocks may be rising for the same reason that oil and interest rates are heading higher: expectations for a big recovery later in the year that would increase demand.
“Rising oil is tremendously bullish for airlines,” says Bernstein analyst David Vernon. “Prices are going up because the market is getting optimistic that the rollout of vaccines will result in better economic activity.”
Higher oil prices have pressured the sector in the past, but that has usually been due to a supply shock, such as trouble in the Middle East. If oil prices increase while demand picks up, higher prices can get passed through to consumers.
The industry usually ramps up capacity in a cyclical recovery, but there are countervailing pressures this time. Most carriers have piled on debt during the pandemic. Whatever free cash flow they generate may go toward paying interest and cutting debt. Capital expenditures are also likely to remain depressed as carriers repair their balance sheets.
The U.S. fleet is down about 19% since the pandemic started, with about 1,000 aircraft taken out of service, according to Airlines for America, an industry trade group. Many wide-body planes used for long-haul, international travel may not return for a while, but narrow-bodies for domestic hops could make a quicker comeback.
All of this assumes that oil prices don’t continue to rise and that demand makes a robust comeback. That will hinge on vaccine and pandemic developments. We could also see earnings estimates come down for the first quarter and first half of the year, as industry operating costs increase while revenues don’t gain nearly as much.
But airlines may have pricing power to raise fares as demand picks up. There is usually a three-to-six month lag between oil prices going up and airfares rising, Vernon says. “They’ll fill seats because the economy is reopening, and that’s a greater source of earnings leverage.”
The industry should be in a good position if the bulk of the population is vaccinated by summer. About 20% of travelers make up 80% of the market, says Vernon. “That high-frequency group will travel, and they’ll want to do it at the same time,” he says. “December will be a pretty good month.”
Vernon maintained Outperform ratings on Delta Air Lines (DAL), United Airlines Holdings (UAL), American Airlines Group (AAL), and Southwest Airlines (LUV) this week. But he sharply increased loss estimates for 2021, while slightly raising his 2022 estimates.
Rising oil prices will hurt near-term. If the oil traders are right, however, the long-term outlook is looking brighter.
Write to Daren Fonda at daren.fonda@barrons.com
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February 18, 2021 at 07:00PM
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Why Rising Fuel Prices Are a Good Sign for Delta and Other Airline Stocks - Barron's
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