Airline Stocks: Fueled for Growth

Rarely have the skies looked so clear for the airline business.

The latest indicator came on Sunday, when Moody’s Investors Service bumped up its outlook for the sector from stable to positive.

This year, the credit rating agency sees the industry posting adjusted operating profit margins of 12% to 14% and 11.5% to 13.5% in 2016, well up from an estimated 8.5% to 9.5% last year.

“US carriers will continue to garner the largest increases, leading to stronger performance relative to airlines based in increasingly competitive developing markets and in Europe,” said Jonathan Root, Moody’s vice-president and senior credit officer.

Oil’s Plunge Brings Big Savings

As you’d expect, fuel costs are a big part of the story: according to Moody’s, the average price of jet fuel will fall by $1 a gallon or more in 2015, slashing US airlines’ combined costs by as much as $15 billion, including the impact of hedging (more on that below).

To get a sense of just how much that changes the picture, consider that fuel represents 26% of the industry’s total expenses, according to the latest figures from the International Air Transport Association (IATA).

And that’s not the only way lower fuel prices benefit airlines. The other is higher consumer spending arising from savings at the pumps—and the likelihood that at least some of that cash will find its way into an extra vacation or two.

Higher demand—driven by an improving global economy, higher disposable income and more passengers hopping on planes in the developing world—also registered in Moody’s forecast, which calls for a 5% to 6% increase in passenger growth in 2015 and 2016.

But if you’re waiting for the airlines to pass on their newfound savings in the form of lower fares, you could be in for a long wait. That’s because US carriers continue to see record-high load factors (or the percentage of available seats occupied by paying passengers), lowering the incentive to reduce fares. There’s also less competition in the US airline business these days, due to consolidation.

As a result, airline investors could be bigger winners from the fuel-price plunge. That’s because, according to Moody’s, the carriers are more likely put the savings toward more-efficient planes, improving their balance sheets and increasing shareholder returns.

Two Airline Stocks to Keep on Your Radar

Here’s a look at two airline stocks we cover in our Personal Finance and Canadian Edge advisories, respectively. One is an icon in the US airline business, while the other is a Canadian airline that aims to spread its wings internationally.

Both are benefiting from falling fuel costs and rising demand for their flights.

Just yesterday, Delta Airlines (NYSE: DAL) kicked off earnings season for airlines, reporting its fourth-quarter and full-year results before the opening bell.

Investors responded positively, sending the stock soaring 7.6% on the day. And if you’d bought Delta when Personal Finance first recommended the stock in February 2014, you’d be sitting on a 59.3% total return right now.

The company and its affiliated carriers offer service to 333 destinations in 64 countries. Delta operates a fleet of more than 700 aircraft and boasts a market cap of over $38 billion.

There is a downside to the oil price plunge for Delta, however. It comes in the form of hedging contracts the company entered into to protect itself from rising fuel prices. In the latest quarter, it took a $1.2-billion charge on mark-to-market adjustments on fuel hedges.

But if you exclude special items, Delta earned $0.78 a share in Q4, topping the consensus forecast of $0.77 and marking the fifth straight quarter the airline has beaten the Street’s expectations. Revenue gained 4.6%, to $8.2 billion, though that was short of the consensus forecast of $9.5 billion.

And even with the hedging losses, the airline expects to realize $2.0 billion of fuel savings this year.

Meanwhile, Delta continues to upgrade its fleet, recently inking a deal with Airbus Group for 50 wide-body jets for $14 billion. The contract is split between 25 all-new A350-900s and 25 A330neo aircraft, an upgraded version of its ubiquitous A330.

That’s in keeping with the company’s pattern of purchasing upgraded models of older aircraft instead of going all-out on new models, because they’re cheaper to buy, use proven technology and can be acquired relatively quickly—an important factor in an industry where demand can change quickly.

Delta trades at 10.8 times the $4.88 a share that it’s forecast to earn in 2015. The stock yields 0.80%.

WestJet: Going Global

If you’ve flown anywhere in Canada, you’ve likely run across this low-cost carrier, with its simple two-word slogan: “owners care.”

It’s meant to set WestJet Airlines (TSX: WJA, OTC: WJAFF) apart from its main competitor, Air Canada (TSX: AC), because more than 85% of WestJet’s employees are also shareholders in the company, while Air Canada, the country’s formerly government-owned flag carrier, is a union shop.

It’s an appropriate catchphrase for WestJet, which has built a reputation as a cheap and cheerful domestic carrier since it was founded in 1996. It now employs 9,700 workers and flies to 88 destinations in North America and the Caribbean—but it’s looking to broaden its reach even further.

Next year, it plans to add four 262-seat Boeing 767s to its fleet. These planes will build on the European toehold the company established when it began flying its shorter-range 737s to from St. John’s, Newfoundland, to Dublin last year.

In the third quarter, WestJet’s load factor was 83.1%, up from 82.8% a year earlier. On an adjusted basis, WestJet earned CAD0.66 a share, up from CAD0.50 a year ago, as revenue gained 9.2% ($1 Canadian = $0.84 US).

WestJet trades at 10.2 times its forecast 2015 earnings of CAD3.19 a share. The stock yields 1.42%.

As with other airlines, the oil price plunge will be a big story for WestJet this year, but the Canadian carrier is in a different position than its US counterparts because of the importance of oil to its home country’s economy.

“To be sure, there’s a risk that if oil stays low for a prolonged period, it could slow Canadian economic growth—and travel spending along with it,” wrote David Dittman, chief strategist at our Canadian Edge advisory, in the publication’s January issue. “But for now, lower fuel costs will let WestJet cut ticket prices, boosting demand for its flights.”

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