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Most airline stocks have not rewarded their shareholders well in the first quarter of 2019. With the recent crash of Boeing’s 737 MAX and the uncertainty over the continuing Brexit saga, dark clouds have also rolled in over the industry.
Today, I’d like to discuss the cyclical as well as long-term factors that I believe may drive the price of airline stocks, so that interested readers may also use some or all of them make informed decisions when separating winner shares from the losers. This article will be shortly followed by another one where I’ll highlight which airline shares I’d watch in the coming months.
Industry fundamentals
In 2019, the International Air Transport Association (IATA) expects 1% of global GDP to be spent on air travel. A strong economy, low unemployment, and increased consumer spending worldwide have been the recent tailwinds for the industry.
There are several crucial drivers of change that affect the industry as well as airline management, and for investors, the share price of airlines. These factors include:
- Societal developments, such as urbanisation and demographic changes.
- Economy, such as the price of oil, business cycles and volatility.
- Technology, such as aircraft development, cybersecurity, or the role of social media in customer engagement.
- Environment, such as regulation of emissions and noise pollution.
- Politics, such as regulatory changes, trade protection, and response to terrorist threats.
Within this context, airlines are under constant pressure to improve performance, ensure passenger safety, increase efficiency, become technologically advanced, and at the same time excel in customer satisfaction.
Valuing share price of airlines
The economics of running an airline are quite complex. However, at the end of the day, like any other company, airlines need revenues to cover operating costs and become profitable.
The airline business is capital intensive and substantial investment is needed to accommodate traffic growth. The industry’s two largest operating costs are fuel and labour.
The sources of operating revenue include passenger, cargo, excess baggage and certain other transport-related revenue.
When valuing airline stocks fundamentally, investors usually pay attention to several industry-specific terms that describe an airline’s financial performance. Available seat miles (ASM) is the preferred measure of capacity in the airline industry. For example, an airline with a single plane of 200 seats that flies 5,000 miles per day is generating 1,00,000 ASMs a day.
Then there is passenger revenue per available seat mile (PRASM), a unit of efficiency. It is the division of operating income by available seat miles (ASM). In general, higher PRASM is better. And yield is the average fare per passenger per mile. Yield is a dynamic metric, as it varies for different market segments and different seat classes.
Analysts highlight the importance of economic activity such as GDP levels on air traffic growth and profit levels. They also regard the industry as cyclical. Cyclical stocks rise when the economy is growing and fall when the economy slows down. Fewer passengers and fewer flights lead to declining revenue and profits for airlines companies, which pressures their share prices.
The bottom line on airline stocks
When evaluating airline stocks, in addition to looking at various fundamental metrics, I also pay attention to possible future changes and trends within a geography or society. As travel demand both in the UK and globally increases, I think well-managed airlines may deserve a place in a diversified share portfolio.
