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Load Factors Drop in April: What's in Store for Airlines?

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Load factor (percentage of seats filled by passengers) is an important indicator of profitability and efficiency for airline companies. Higher load factor implies the company is more profitable. This is because a high load factor means that the heavy fixed costs of airlines can be spread across more passengers.

Capacity over growth due to contraction in load factor often causes lower airfares, thereby eroding revenues and profitability of the airline companies. In fact, air fares in the United States decreased in April per data released by the Bureau of Labor Statistics. Per the report, ticket prices reduced 2.7% on a month-to-month basis, registering the sharpest fall in four years.

Apart from declining load factors, let’s have a look at the other headwinds plaguing the airlines.

Fuel Costs

Fuel costs have been on the rise lately due to various reasons such as geopolitical tensions in the Middle East. Oil prices increased 5.6% in April. President Donald Trump’s decision to withdraw from a nuclear deal with OPEC-member Iran has further spiked oil prices.

Currently oil prices are hovering at around $71 a barrel. As expenses on fuel comprise a significant portion of airlines’ operating expenses, rise in the metric inflates costs, thereby limiting bottom-line growth.

In fact, high fuel costs hurt American Airlines Group Inc. AAL results substantially in the first quarter, resulting in the stock losing value post the earnings report, despite outperforming on the bottom-line front. Such exorbitant costs are expected to hamper results in the coming quarters as well. Moreover, the company trimmed its current-year earnings guidance mainly due to high fuel costs.

Southwest Airlines' bottom line in the second quarter is also likely to be affected on the same ground. Economic fuel costs are projected at $2.20 per gallon, much higher than the year-ago figure. Also, at JetBlue Airways Corp. JBLU, fuel cost is anticipated to be $2.23, way above $1.61 reported a year ago.

Labor Costs

With labor deals very much in vogue in the airline space, such costs are also on an upswing. The airline employees claim that despite the airlines generating record profits, they lag in terms of employee remuneration. This has in turn propelled frequent new labor deals across the airline industry.

Moreover, per International Air Transport Association (IATA) forecast, labor cost will comprise the major portion of airline expense this year. Labor costs are predicted to account for 30.9% of total expenses in the year compared with 20.5% of fuel costs.

Most recently, JetBlue reached an agreement in principle with its pilots. Final ratification of the agreement by the pilots is still pending. The airline currently estimates non-fuel unit costs between 2% and 4% in the second quarter. The measure is likely to go up following ratification of the new contract. Earlier in March, Spirit Airlines, Inc. ratified its five-year deal with pilots, pertaining to wage increase.

In-Flight Glitches

The airlines have also grabbed headlines of late due to several unpleasant cases on board. Southwest Airlines made maximum headlines in this regard. A tragic incident in April sparked large-scale dissatisfaction among customers with the carrier having made an emergency landing at the Philadelphia International Airport due to an engine failure, which resulted in a passenger’s death with seven others sustaining injuries.

Southwest Airlines has been struggling with low bookings ever since this fatal incident. In fact, the carrier issued a bearish view on unit revenues for the second quarter, thanks to the same reason. It expects revenue per available seat mile (RASM: a key measure of unit revenue) to decline between 1% and 3%.

Similar occurrences took place this May as well. Earlier in the month, the carrier made an abrupt landing when one of its window panes broke. Further adding to the woes, another Southwest Airlines flight was forced to make an emergency landing only a few days ago due to a pressurization issue, throwing the passengers in a tizzy.

In April, a CBS News report titled "60 Minutes" leveled allegations against Allegiant Travel Company that the company is afflicted with a large number of mechanical problems. The report, aired on Apr 15, further stated that the poor safety standard was responsible for around 100 serious mechanical events in the January 2016-October 2017 time frame. The charges are being investigated.

United Airlines also kicked up a controversy, resulting in the tragic death of a black French bulldog puppy on one of its flights in March.

These untoward incidents have been dampening the airline companies’ reputation and certainly do not bode well for the sector participants.

Price Performance

The Zacks Airline Industry fared poorly due to the headwinds, massively underperforming the broader market on a year-to-date basis. The S&P 500 index gained 2.1% against the industry’s decline of 12.9%.

Conclusion

Despite an air of prevalent pessimism revolving around airline stocks, we expect the companies to make a turnaround soon, buoyed by strong demand for air travel and rising air fares. With soaring oil prices, the carriers will most likely pass on the high-cost burden to passengers’ pockets. Notably, during first-quarter 2018 earnings release, American Airlines CEO Doug Parker warned of dearer ticket prices.

Thriving U.S. economy augurs well for travel-focused stocks like airlines. With consumer confidence remaining strong, more and more Americans are resorting to vacations. Demand for air travel is expected to remain robust, courtesy of a much-enhanced job market and an increasing disposable income.

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