Last January I wrote about the airline sector and concluded that after a spectacular 2013 performance, it was ahead of economic fundamentals and due for a pullback, especially if expectations for a resurgence in economic activity in 2014 were not realized.
Although first-quarter GDP was terrible and downward revisions for second-quarter GDP are now being announced by many banks, most of the airline stocks have continued their spectacular performance.
Conversely, though, the share price of United Continental Holdings (UAL) is down about 13%, which is more in keeping with what I was expecting from the sector this year.
These returns are inclusive of a pullback in the share prices of all four names today of about 3% at American, 5% at Delta, 5.5% at United and about 0.5% at Southwest.
Today's action is both technically and fundamentally driven. United's share price broke below its 200-day moving average earlier today, as Delta announced that its June revenue was below earlier forecasts.
These two issues combined to spill over into the other airlines, as speculators began to consider whether or not the airlines were indeed finally ahead of economic fundamentals.
One of the prime drivers of these stocks has been the belief that the reduced number of carriers caused by domestic mergers would return pricing power to the sector. This notion has proven to be true. Over the past year, airline ticket prices indeed have been rising along with oil prices and faster than price inflation, but they've also been rising faster than incomes.
Discretionary, non-business travelers simply do not have the financial capacity to absorb prices rising faster than incomes.
On top of that, the aviation security fees added to each airline ticket to help fund the Transportation Security Administration have more than doubled starting this month, as required by the Bipartisan Budget Act of 2013, from $2.50 per flight to $5.60. Those fees are charged per flight, not per ticket; which means trips requiring connecting flights will have each leg of the trip charged the extra $3.10.
Unlike many other sectors, it is difficult to ascertain the impact of share buybacks or issuing on airline stock prices.
American's shares outstanding have increased 300% since the beginning of the year and 500% since the beginning the fourth quarter of last year as a result of the US Airways merger. Delta's outstanding shares are very close to where they were at the beginning of the year. Southwest has repurchased about 1.5% of its stock since the beginning of the year. United is a bit of a different story, though, with the number of outstanding shares increasing 3% over the past six months and by 12% in the past year.
There's been almost no change on the dividend front, with American and United paying none and Delta and Southwest paying little (yields of 0.6% and 0.9%, respectively).
The bottom line is that I continue to believe that these stocks are priced ahead of what the economy can support.
American has tripled over the past three quarters, while Southwest and Delta have roughly doubled, and even United is up 40%.
For a mature industry with low margins and little or no dividends, the performance of these stocks since the beginning of the year, with the exception of today, looks like a blow-off top.
I finished the January column with the following:
At this stage, the most prudent course of action for speculators, in my opinion, is to sell them, take the profit and wait for the correction, which I believe is more probable than not.
I think that's still good advice.