Airline stocks start to take off

Drop in capacity projections boosts airline shares, with the group up 9.9% since its late June low.

  • By Amrith Ramkumar,
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Airline stocks have begun to rebound after a monthslong downturn, a bullish sign for investors who watch shares of transportation companies as a gauge on the global economy.

After tumbling 20% from its January peak through late June, the NYSE Arca Airline Index (.XAL) has risen 10% and climbed in five sessions through Monday before falling less than 0.1% Tuesday. In the past month alone, Southwest Airlines Co. (LUV) shares have added 14% and Delta Air Lines (DAL) is up 11%.

The recovery has lifted the Dow Jones Transportation Average, which Tuesday set its first record since January. Analysts use the performance of transportation companies as an economic indicator because demand for their services is typically closely tied to global growth.

Earlier this year, continuing trade tensions had hurt growth-sensitive assets such as transportation stocks. But more recently, many large industrial companies have generally reported robust second-quarter demand—leading some analysts and investors to boost their outlook on the economy.

Despite worries that tariffs are starting to curtail growth outside the U.S., investors have been encouraged that Chinese and U.S. negotiators are mapping out talks to try to end their trade standoff ahead of planned meetings between President Trump and Chinese leader Xi Jinping at summits in November.

With sentiment about growth improving, airline shares have helped the S&P 500 (.SPX) rise in the four latest sessions and reach a new intraday record. On Monday, American Airlines Group Inc. (AAL) was the index’s second-best performer, climbing 5.8%, and every airline stock in the index added at least 3%.

After airline operators and other industrial firms surprised some analysts on recent earnings calls by saying demand largely remains favorable, some expect the group to continue marching higher.

“The industrial sector across the board really said things are continuing to hum along nicely,” said Charlie Smith, chief investment officer of Fort Pitt Capital Group. “The trade problems that I’ve seen have been very isolated.”

Some investors have long been looking for opportunities outside crowded technology and internet stocks and think beaten-down airline stocks could fit the bill. American, Delta, and United Continental Holdings (UAL) all have price/earnings ratios below 10, based on expected profits in the next 12 months.

That compares with the more expensive valuations of 17 for the broader S&P 500 and 19 for the index’s information-technology sector.

Industry analysts point to two other main catalysts for the reversal in airline stocks: a drop in company projections for the number of passenger seats offered and moderating energy prices. Investors tend to fret about a rise in seats offered because airplanes flying with too many unsold seats are less profitable and quicker-than-expected expansion by operators can bring ticket prices lower.

Worries that a rise in passenger capacity would lead to emptier planes and fee competition had punished airline stocks before second-quarter earnings reports, with trade developments and higher fuel prices adding to the bearish sentiment.

But now that airline operators have lowered projections for capacity growth, some analysts expect the sector to stabilize. On Tuesday, American said it is cutting some unprofitable international flights, the latest example of carriers adjusting their business plans.

“It gives the market a little more confidence that revenues can improve and offset some of the effect of higher fuel prices,” Stifel analyst Joseph DeNardi said.

Lower fuel expenses also could give airline shares a boost. After a monthslong rally that analysts say caught airline companies off-guard, U.S. crude has declined 10% from its June multiyear high, though it is still up nearly 40% in the past year.

Some analysts think higher supply from large producers such as Saudi Arabia could keep a lid on oil prices, potentially relieving some cost pressure on big fuel consumers such as airlines.

Despite the sector’s recent rise, some investors expect fresh trade developments to loom over transportation shares as tariff negotiations continue. And after months of investor anxiety over capacity, some analysts think investors will want to see sustained share performance and future projections before taking a fresh look at beaten-down airliners.

“While this is an encouraging first step, all eyes will be on 2019 plans,” Raymond James analysts said in a note to clients earlier this month.

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