May 21, 2018, by Lewis Krauskopf
NEW YORK (Reuters) – Shares of U.S. airlines have been depressed by rising oil prices this year, but their descent to relatively cheap levels could position them for takeoff.
Just since mid-March, the S&P 1500 airlines index .SPCOMALI has tumbled more than 10 percent. While other factors, including broader market volatility, are weighing on the shares, the decline has coincided with an 18 percent rise in U.S. crude oil prices CLc1 to over $70 a barrel.
An expected strong summer travel season could lure investors back to the stocks with more enticing values in the face of higher fuel prices.
Fuel is one of the biggest costs for airlines, with analysts saying they generally make up about one third of operating expenses.
“Investors have been concerned about oil prices all year long,” said Jim Corridore, an analyst covering airlines at CFRA Research.
Over the past 50 trading sessions, there has been a strong inverse correlation between the airline index and oil prices, according to Thomson Reuters data, meaning they tended to move in opposite directions over this period. That link is the strongest it has been in about two years.
U.S. crude oil has climbed by about $10 a barrel over that time, and is now trading at about $72 a barrel, while Brent crude LCOc1 topped $80 last week for the first time since late 2014.
The price of jet fuel has rallied in New York JET-NYH and other markets, and the benchmark diesel futures contract from which jet fuel is priced has risen to the highest since early 2015 HOc1.
“I would guess when oil prices stabilize at some point you will see the correlation break down, but there is still some uncertainty about where oil prices are going to go,” said Stifel analyst Joseph DeNardi, who covers airlines.
Other transport companies, such as trucking, railroads and parcel delivery companies, can readily enact fuel surcharges, making them less susceptible than airlines to higher oil prices, said Morningstar analyst Keith Schoonmaker.
Airline stocks arguably offer more value with their recent swoon. The five airlines in the S&P 500 – Delta Air Lines Inc (DAL.N), United Continental Holdings Inc (UAL.N), American Airlines Group Inc (AAL.O), Southwest Airlines Co (LUV.N) and Alaska Air Group Inc (ALK.N) – as a group recently traded at about 8.4 times forward earnings estimates, their lowest level since late 2016, according to Thomson Reuters Datastream.
The stocks are trading at a nearly 49 percent discount to the S&P 500, on a forward price-to-earnings basis, compared to their average discount of 39.5 percent over the past five years.
“As a group, there is pretty good value there,” said Chuck Carlson, chief executive officer at Horizon Investment Services in Hammond, Indiana, which owns shares of Southwest and SkyWest Inc (SKYW.O).
A silver lining to higher oil prices would be if it forces airlines to rein in the amount of flights being flown, DeNardi said. Fears of too much capacity and an airline price war spooked investors earlier this year.
“What the market and what investors have wanted have been for airlines to respond to higher oil prices by reducing capacity and they haven’t gotten that yet,” DeNardi said.
Asked at an investor conference last week about cutting capacity, Delta Chief Financial Officer Paul Jacobson said the company was poised for a “record summer” in terms of customers carried as well as for “one of the most profitable summers that we’ve seen.”
“So the time to really make those decisions is post that summer period, and we still have a few months to just kind of watch the environment, see how it looks, see what happens to oil prices … before we have to make those decisions,” Jacobson said.
Indeed, the arrival of the seasonally strong summer months on top of already strong demand is one reason why CFRA’s Corridore believes airline stocks are due for a resurgence. Benefits from lower corporate taxes, stemming from the tax cut bill passed by Congress in December, outweighed higher fuel costs in the first quarter, according to Corridore.
“I understand why investors are concerned about it, but I expect oil to stabilize because of supply coming out of the U.S.,” Corridore said.
Additional reporting by Terence Gabriel and Jessica Resnick-Ault in New York; editing by Alden Bentley and Bill Berkrot