Key Trends Driving Airline Stocks: Delta, Southwest, US Airways

The airlines are undergoing a difficult period of economic uncertainty and increasing dependency on external factors. As the global financial crisis still remains a looming concern, the airlines are managing capacity cuts to cut costs and expect very marginal ASM (Available Seat Mile) growth expected this year. Southwest Airlines (NYSE:LUV), Delta Air Lines (NYSE:DAL), US Airways (NYSE:LCC) managed to report marginal profits due to benefits from special items. While the first quarter ended up in losses for most of the US airlines excluding special items, the carriers are expected to continue to face challenging times ahead. Burdened by spiraling fuel prices, the IATA (International Air Transport Association) has also lowered its global profit forecast for 2012 by 14% to $3 billion. Below, we analyze the trends that are going to impact the financial performance of the airlines this year.

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Fuel Price Turbulence

Rising jet fuel prices have badly hit the airline’s bottom-line this season. The data for US airline fuel cost and consumption reported by Bureau of Transportation Statistics clearly demonstrates the magnitude of damage it has done to the airline financials. Fuel and oil costs were up 45.5 percent this quarter for Southwest, an airline which is known for its fuel hedging strategies. This is despite the fact that airlines have cut down on their fuel consumption through capacity optimization and adoption of fuel efficient aircraft. The IATA has already revised its oil price estimates for 2012 from $99 to $115 per barrel. Fuel, which constitutes more than a third of the airline’s operating expenses, is going to have a significant impact on the earnings going forward.

The airlines have been following a trend of taking a M&A route towards a relative better performing carrier. Some of the successful M&A deals in the last few years include Delta – Northwest, Southwest – AirTran, United-Continental (NYSE:UAL), etc.

As these mergers go through, the merged entity is able to leverage better economies of scale, and has better control over the operational expenditures through route optimization and process integration programs. In effect, it gives the merged airline an advantage over the competitors in terms of pricing and facilitates broader service offerings under the same brand. The recently proposed merger between US Airways and AMR (NYSE:AMR) owned American Airlines is making good progress with approvals from labor unions and backing from AMR’s creditors. As AMR agrees to explore potential merger scenarios, we may see bids from other rivals such as Delta Air Lines as well.

Non-Fuel Cost Optimization

With increasing fuel price turbulence, the effectiveness of hedging strategies seems to be fading away. In such scenarios, almost all the airlines are planning to cut down their non-fuel expenses and as a result bring down the CASM (Cost per Available Seat Mile) excluding fuel.

Alaska Airlines (NYSE:ALK) improved employee productivity by 4.7% in this quarter to offset the increased fuel costs. Going forward, it plans to deploy slimmer and lighter cabin seats in the 22 new Boeing 737-900ERs which would realize annual fuel savings of 8,000 gallons per aircraft. Southwest Airlines, on the other hand, is planning to add six more seats to 737-700 aircraft, which cover 60% of the total fleet size. The revenues generated from additional seating space would compensate for a part of the rising costs. Delta Air Lines is working towards improving maintenance efficiency, retiring inefficient aircraft and improving employee productivity. US Airways is also planning to replace 15 older 737 leased aircraft with 12 A321s which will increase the capacity by 1.5% and also optimize fuel costs. Going forward, we may see more innovative cost cutting measures used by the airlines to improve their bottom-line.

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