The Turbulent Times for Airline Stocks
For a period of time, airline stocks experienced a tear. The Dow Jones airline index was up 75% during the 12-month period, which ended last July. Airlines enjoyed high profits last 2014 due to the combination of cheap fuel prices and high airfares. The trend continued into the first quarter of 2015.
Last week, however, airline stocks took a nosedive. The six-day period that ended last Tuesday was considered the worst stretch of airline stocks experienced in seven months. After dropping 2.4% on Tuesday, stocks nearly dropped 9% over the past week. The shares of notable air companies such as Southwest Airlines, American Airlines and Delta Airlines have all dropped by more than 10%. Many spectators wonder about the reason behind the drastic drops.
Many point their fingers at Southwest for its crime—expansion. Despite the recent uptick of fuel prices, the airline stated that it would save at least $1.2 billion in fuel costs compared to 2014. The idea of cheaper fuel costs enticed airlines to add more flights and routes. The carrier expects the current seating capacity to grow from 7% to 8% this 2015 compared to 2014. In 2016, the airline foresees the capacity grow from 6% to 7%.
Expanding business when costs are low appears idyllic and a wise decision in a business sense. Yet over the previous years, airlines emphasized the importance of capacity discipline over growth as a means for higher profits. Such method has slaughtered unprofitable business routes and scaled back services at former hubs like St. Louis and Cleveland in order to keep all flights fully booked.
United CEO, Jeff Smisek, summed up the unofficial mantra of the airline industry when he said, “We will absolutely not lose our capacity discipline … It is very healthy for us and very healthy for the industry.”
From an investor’s point of view, Southwest’s growth plans sabotage the works. “Domestic capacity discipline has effectively vanished,” Wolfe Research airline analyst Hunter Keay said with respect to Southwest’s move.
Southwest currently ups the competition for customers. The scenario proves favorable for travelers, who have been subjected to rising travel fares across the board. Travelers also face fewer route choices due to the airlines’ decision to maintain discipline for the sake of higher profits.
On the other hand, Southwest competitors do not agree with this turn of events due to the forced competition with more flights and lower fares. Many airlines prefer to increase capacity only when there is an overwhelming demand and when there is an assurance of high airfares. Airline industries prefer less competitive industries for steadier and higher profits.