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What Headwinds? Airlines To Book Their 10th Straight Year Of Profitability

By Frank HolmesStock MarketsJan 28, 2019 12:55PM ET
www.investing.com/analysis/what-headwinds-airlines-to-book-their-10th-straight-year-of-profitability-200380170
What Headwinds? Airlines To Book Their 10th Straight Year Of Profitability
By Frank Holmes   |  Jan 28, 2019 12:55PM ET
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Domestic airlines weren’t exempt from the rout that hit stocks in December, the market’s worst month since the Great Recession. Shares of all four major U.S. carriers—American (NASDAQ:AAL), Delta (NYSE:DAL), United Continental (NASDAQ:UAL) and Southwest (NYSE:LUV)—saw double-digit losses. Delta ended December down 17.8 percent, its worst month since October 2009, when it gave back 20.3 percent.

The losses appeared to extend into the new year. On January 3, Delta forecast slightly slower revenue growth on concerns of a global economic slowdown, not to mention the partial U.S. government shutdown. In its first month, the shutdown—which ended Friday as President Donald Trump signed a bill to extend spending for three weeks—cost the U.S. aviation industry about $105 million, according to consulting firm ICF. Delta’s stock lost almost 9 percent for the January 3 trading day. Shares of the other three major airlines fell as well, though not by as much.

I believe the selloff was overdone, and the market seems to have agreed. Investors who bought the dip were rewarded. From January 3 to January 25, Delta shares recouped about 4.5 percent. Over the same period, the NYSE ARCA Airline Index soared about 14.7 percent.

Ancillary Revenues Helped Offset Higher Fuel Costs in 2018
Much of this enthusiasm was driven by better-than-expected full-year and fourth-quarter earnings reports from a number of domestic carriers.

For 2018, United reported an impressive earnings per share (EPS) of $7.70, up 9 percent from 2017. This came even while total fuel costs were 34 percent higher. The carrier is now projecting an EPS of between $10 and $12 this year, based not just on increased demand but also growing ancillary revenue.

As a reminder, “ancillary revenue” includes all non-ticket items such as baggage fees, assigned seating, credit cards, loyalty programs and more. According to consultancy firm IdeaWorks, such fees on a global scale stood at a mind-boggling $92.9 billion in 2018, an increase of 312 percent since 2010. Of that amount, the “big four” U.S. airlines netted close to $27 billion. Taken together, these additional revenues have helped airlines offset rising fuel and labor costs.


Global Airline Ancillary Revenue Even Larger  in 2018
Global Airline Ancillary Revenue Even Larger in 2018

Delta said as much in its own earnings report. For 2018, operating revenue was up 8 percent year-over-year to $44 billion “on an increasingly diverse revenue base, with 52 percent of revenues from premium products and non-ticket sources." The Atlanta-based carrier reported $1 billion in profits in the fourth quarter, an unbelievable increase of 240 percent from the same three months in 2017. That amounted to an EPS of $1.49, compared to $0.42 the previous year.

American also reported stellar earnings, and CEO Doug Parker tantalized the market with exciting guidance for this year. “At the midpoint of our guidance, 2019 diluted earnings per share, excluding special items, would increase approximately 40 percent versus 2018,” Parker said. Shares of American popped as much as 6.4 percent on the news.

10th Straight Year of Profitability?
Despite the recent spike in market volatility, I believe the investment case for global airlines looks favorable going forward. I’m not alone. In a press release dated January 23, Moody’s Investors Service stressed that although economic growth could be slowing worldwide, airlines are well-equipped financially for the next 12 to 18 months. The ratings agency writes that “the global passenger airlines industry is stable on steady operating margins, supported by higher passenger volumes, mixed growth in pricing and modestly lower fuel costs.”

If all goes according to plan in 2019, the global airline industry will have achieved something it’s never managed to do—that is, log 10 consecutive years of profitability. In its 2019 outlook, the International Air Transport Association (IATA) believes this will be the case, with net profits estimated at $35.5 billion, slightly ahead of 2018’s $32.3 billion. “An industry first,” the Geneva-based trade group tweeted on December 27. “2019 forecast to be 10th consecutive year of profitability for the global airline industry.”

Long-Term Outlook: Air Travel Demand Could Outpace Economic Growth
Looking ahead even further, 10 to 20 years, I think that airlines could be a profitable way to participate in the expansion of incomes around the world. In about a decade, an estimated 200 million people—many of them concentrated in developing countries such as China and India—are expected to join the middle class and, for the first time, be able to afford the cost of airfare, according to a new report by consulting firm Oliver Wyman.

Air travel has historically been tied to change in a country’s or region’s gross domestic product (GDP), but there’s reason to believe that demand will actually outpace economic growth. For the past decade, air passenger traffic growth—as measured in revenue passenger kilometers (RPFs)—has already been faster than GDP growth on an annual basis. Analysts at Boeing (NYSE:BA) now believe this trend will continue for the next 18 years. With a 6 percent compound annual growth rate (CAGR), African countries are projected to undergo the greatest expansion of any other region, followed by Latin America and Asia. Highly developed regions such as Europe and North America will likely see the weakest change year-to-year, but even then, air travel demand growth is expected to be faster than economic growth.

Air Passenger Demand Projected to Outpace Economic Growth in Every Region
Air Passenger Demand Projected to Outpace Economic Growth in Every Region

More Than a Billion Indian Passengers by 2040?
For a moment let’s look just at India, currently the second most populous country on earth. One of the world’s fastest growing regions, it’s expected to replace the U.K. this year as the fifth largest economy. According to the Federation of Indian Chambers of Commerce and Industry (FICCI), which hosted the Global Aviation Summit this month in Mumbai, India today has the world’s seventh largest aviation market with 187 million passengers. By 2022, it could be the third largest.

And if the trend continues, India could very well be the largest aviation market in the world with around 1.12 billion passengers flying to, from and within the South Asian country. That’s an incredible sixfold jump from 2018.

Projection of Total Passengers To, From and Within India
Projection of Total Passengers To, From and Within India

To accommodate so many passengers, the fleet size of scheduled airlines would need to expand dramatically. The FICCI believes the number of aircraft in India could swell from 622 in 2018 to as many as 2,360 by 2040.

This, of course, would benefit manufacturers such as Boeing, which FORTUNE just named as the most admired aerospace company in its annual list of the “World’s Most Admired Companies.”

Boeing Just Unveiled Its Self-Driving Air Taxi
The jet maker recently showed off the progress of its planned self-driving air taxi, which it is building in cooperation with ride-hailing company Uber. “Uber Air,” as it’s called, is a battery-operated, autonomously flying vehicle, with a range of about 50 miles. Morgan Stanley Research estimates that the market for “autonomous urban aircraft” could be as large as $1.5 trillion by 2040. Boeing, which is projected to have a 40 percent market share of all aircraft by 2025, is well-positioned to take the lead in this exciting new technology.

Disclosure: This commentary should not be considered a solicitation or offering of any investment product. Certain materials in this commentary may contain dated information. The information provided was current at the time of publication.

What Headwinds? Airlines To Book Their 10th Straight Year Of Profitability
 
What Headwinds? Airlines To Book Their 10th Straight Year Of Profitability

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