In both columns, I advised selling these names. The group's performance this year has been inconsistent as there is no evident industry cohesion. That's rather strange because the principal narrative promulgated by the financial media has been that the largest airlines would all benefit from industry consolidation, which allows for reduced competition and increased pricing power, coupled with a resurgence in economic activity. But the stock performances of the largest companies is not reflecting this thesis.
Since June, American Airlines (AAL) and Delta Air Lines (DAL) are lower by about 21% and 10% respectively; but Southwest Airlines (LUV) and United Continental Holdings (UAL) are up by 17% and 10%, respectively.
Since I first wrote about these stocks, on Jan. 28 of this year, the performance has been somewhat better but still not consistent. American, Delta and Southwest are up 4%, 11% and 51% since then, while United is down by about 5%. There is no longer an airline ETF available, so in order to get the phenomenal return from Southwest, an individual investor would have had to directly invest in them.
I reviewed all of the economic reasons working against the airline business in the previous columns and won't reiterate here. It all still applies though. From a business perspective, I've never liked the airlines as stock investments because they don't fit any standard investor need.
They provide little growth. The four considered here represent 80% of the current industry revenue and passenger miles. That degree of consolidation should have resulted in the pricing power expected and increases in revenue, earnings, and stock prices as a result. It hasn't.
There's been an increase in airline ticket prices that has largely reflected the increase, until recently, of the cost of jet fuel. They provide little income, with dividend yields of between 0% at United and 1.1% at American. Again, the pricing power expected by way of consolidation is not getting to the bottom line and out to investors.
The industry is also highly unionized with high fixed costs for fuel, maintenance, and other overhead that must be serviced regardless of the economic environment and demand for their service. And this is where the rubber meets the runway with respect to this industry and the potential for investor returns.
Below is a chart of U.S. airline passenger miles travelled annually between 1998 and the present, adjusted for the size of the U.S. population (see the black line). The red line shows the average rate of change in the demand for airline travel with two big dips: The NASD bubble collapse and September 11, 2001 events are in the first dip and the 2008 financial crisis is in the second.
There has been a bounce back in demand for airline travel after the events of 2000 and 2001. The bounce back since 2008 has been far smaller -- the growth rate in demand for air travel has held steady over the past few years -- at about the same as the growth in the population.
That's bad, but it's probably going to get worse as the U.S. demographic profile ages. The ability of the industry to grow in that environment will be predicated on broad economic strength to provide demand and create top-line revenue. Getting that top-line revenue to the bottom line will require decreasing costs through more fuel efficient engines mounted on planes carrying more passengers.
The big problem for the airlines, however, is that this has to occur at a scale faster than the increased costs of fuel and debt that must be taken on to upgrade the fleets. Even though oil prices have been falling recently, the long-term trend of prices continuing to increase faster than inflation is a major headwind for the industry.
The bottom line for traders, speculators and investors is that there are plenty of other preferential areas to deploy capital into. Allocating that capital to airline stocks incurs a lost opportunity cost -- regardless of the immediate returns to companies such as Southwest.