Iraq Conflict Once Again Highlights Airlines’s Vulnerability To Oil Price Rise
Stocks of all major U.S. airlines including American (NASDAQ:AAL), United (NYSE:UAL), Delta (NYSE:DAL), Southwest (NYSE:LUV), JetBlue (NASDAQ:JBLU) and Alaska (NYSE:ALK) fell by around 4-5% on Thursday, June 12, as crude oil prices rose amid concerns that the conflict in Iraq could affect global oil supplies. Brent crude oil price rose by around 3% to $113.22 per barrel, while WTI crude oil price rose by around 2% to nearly $106.50 per barrel. [1] [2] This is the highest price level for both Brent and WTI crude oil since September last year. Airline stocks were hit particularly hard by this sudden rise in global crude oil prices as jet fuel costs constitute around a third of an airline’s total expense.
In 2014 so far, U.S. airline stocks rose steadily driven by the solid demand for air travel and expectations of stable crude oil prices. This expectation of stable crude oil prices was driven by the rising crude oil production in the U.S. But with the conflict in Iraq threatening to impact oil exports from the country, global oil prices jumped because Iraq is the second-largest oil producer in the Organization of the Petroleum Exporting Countries (OPEC). We figure if this jump in global crude oil prices persists over the next few weeks, then it will seriously impact the second quarter profits of U.S. airlines.
To understand this relativity, let us look at Southwest Airlines. Last year, jet fuel costs constituted around 35% of Southwest’s total operating costs. So, a significant jump in the carrier’s fuel costs driven by this oil price rise will have a considerable effect on its total costs. At the same time, Southwest’s operating margin was slightly over 7% last year. [3] Hence, the carrier does not have much room to absorb higher fuel costs. In any case, the thin margins of the airline maks it highly vulnerable to large hikes in oil prices. Such thin margins and high vulnerability to oil price rise are not limited to Southwest, but are a prominent feature across all airlines. So, every time global crude oil prices jump significantly, airline stocks usually fall. Additionally, its not as if airlines do not try to pass on higher fuel costs to fliers through passenger fare hikes, but fares rise is limited by the intense competition that prevails in the airline industry. Airlines fear that a unilateral hike in fares will push passenger traffic to other airlines thus impacting their occupancy levels (percentage of seats occupied by passengers in a flight) and profitability.
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This latest escalation of the conflict in Iraq has once again highlighted airlines’ vulnerability to oil price rise.
We currently have a stock price estimate of $25.30 for Southwest, marginally below its current market price.
See our complete analysis of Southwest Airlines here
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Notes:- Brent crude oil price, June 13 2014, www.nasdaq.com [↩]
- WTI crude oil price, June 13 2014, www.nasdaq.com [↩]
- Southwest’s 2013 10-K, February 2014, www.swamedia.com [↩]