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Is It the Right Time to Buy Airline Stocks?

The airlines industry is poised for strong growth in the near future. In the recently concluded third quarter of 2014, most airlines companies posted solid numbers despite the Ebola outbreak and unfavorable economic conditions. Improved momentum on the freight side and the downtrend in oil prices coupled with increased demand for passenger traffic provide the tailwind for the industry.

As per the World Tourism Organization (:UNWTO), in the first eight months of 2014, foreign tourist arrivals rose 5% globally as compared with the same period in 2013. For full-year 2014, they are expected to grow between 4% and 4% annually. This is likely to act as a long-term positive for the airline industry.

In addition, the industry is gearing up to counter the widespread occurrence of infectious diseases like Ebola, SARS and Avian Flu which may significantly hamper travel plans. In keeping with this, International Air Transport Association (:IATA) recently rolled out an Emergency Response Plan and Action Checklist which aim at limiting the spread of such diseases.

We discuss a few factors of the airlines sector that investors should consider and look forward to in the coming months:

Opportunities

We believe industry-wide consolidation and various sources of ancillary revenues will boost profits and cost performance of most air carriers going forward. This is a suitable time for companies to make strategic collaborations in a bid to enhance profits and operational efficiency.

Mergers & Acquisitions: Airline companies merge to restore profits and broaden the area of their operations. This is apparent from the past mega-mergers within the industry including the ones between Northwest Airlines and Delta Air Lines in 2008, United Airlines and Continental Airlines in 2010 and AirTran Holdings and Southwest Airlines Co. (LUV) in 2011. All three companies -- Delta Air Lines (DAL), United Airlines (UAL) and Southwest Airlines -- are long-term beneficiaries on capacity and cost fronts.

The recent collaboration between U.S. Airways Group Inc. and AMR Corporation has created the largest global carrier, American Airlines Group Inc. (AAL). Despite the merged entity enjoying more pricing power and control over a larger number of slots, we believe it will have little effect on the dynamics of the U.S. aviation industry as 80% of the market will be dominated by the new American Airlines, United Airlines, Delta and Southwest Airlines.

Additional Revenue Gains: Air carriers are increasingly focusing on passenger satisfaction to drive growth. JetBlue Airways Corp. (JBLU) enhanced its TrueBlue loyalty program by allowing a single customer to earn and use points as a group, while Delta has upgraded its Economy Comfort seating in all transcontinental flights operating from New York’s JF Kennedy Airport to Los Angeles, San Francisco and Seattle. The IATA projects total revenue of $746 billion in 2014 from an estimated 3.32 billion passengers traveling this year. Meanwhile, American Airlines plans to offer various attractive perks to the US Airways Dividend Miles club members by clubbing the program with the existing AAdvantage loyalty in the second quarter of 2015.

Expansion: North American carriers are relentlessly focusing on expansion of their range of domestic and international flights. Recently, United Continental announced plans of launching four new Pacific routes to fortify its presence in the region. The company also launched non-stop flights between Los Angeles and Melbourne and between San Francisco and Haneda airport in Tokyo. Meanwhile, flights from its Guam hub to Seoul and Shanghai began Oct 27 and Oct 28, respectively. The company further plans to introduce services to Chile, the Dominican Republic and Belize starting Dec 2014.

Recently, JetBlue initiated a daily non-stop service from Salt Lake City International Airport to Orlando International Airport. JetBlue flyers availing this new route will also enjoy unlimited free snacks and non-alcoholic drinks. In addition, the company’s recent agreement with British Airways (BA) will incorporate 18 daily transcontinental British Airways flights, more than 50 routes within the U.S. and over 100 routes beyond London. Meanwhile, Southwest Airlines launched non-stop flights between Dallas Love Field and eight more cities in the U.S.

Delta Airlines is strengthening its position in Seattle by adding several domestic and international destinations from the western coastal city in addition to reinstating its Barbados operation after a gap of three years. Likewise, after operating for several decades within the U.S. domestic market, Southwest Airlines is finally foraying into international territories, with introduction of flights to the Caribbean.

New Choices: The creation of American Airlines has opened up new opportunities for Southwest Airlines, JetBlue and Virgin America as the merged entity has divested take-off and landing slots at Washington’s Reagan National Airport (DCA) and New York’s LaGuardia Airport (:LGA). Further, American Airlines is currently in the process of divesting gates and related facilities at each of the Boston, Chicago, Dallas, Los Angeles and Miami airports.

Meanwhile, JetBlue signed an interline agreement with British Airways. The two carriers will incorporate 18 daily transcontinental British Airways flights, more than 50 routes within the U.S. and over 100 routes outside London.

Technology Upgrades: Air carriers are opting for numerous technology upgrades and system automation for activities such as airline reservation, flight operations and website maintenance. These upgrades allow companies to function effectively and efficiently, minimize expenses and render better customer service. A4A believes that such up gradation program has compelled the airlines industry to spend nearly $10 billion in capital infrastructure in the first nine months of 2014.

Moreover, availability of faster in-flight Wi-Fi connectivity has encouraged these carriers to roll out entertainment services for travelers. Recently, United Airlines has introduced a new application called United app, which will allow passengers to access a wide range of movies and television shows while on board through Wi-Fi-enabled mobile devices and laptops.

Deployment of on-board wireless services and installation of the Automated Passport Control (APC) kiosks will continue to drive the sector’s modernization program. APC will allow international passengers to enjoy faster and smoother passport clearance. Further, mobile boarding pass is a new technological advancement that allows passengers to use smartphones to get through security check points and board flights sans any inconvenience or delay. In Singapore, the Changi airport has started electronic feedback system which is helping the airport authorities to provide better service.

Emergence of Smaller Carriers

Although consolidation within the U.S. aviation industry will reduce competition, it is expected to be temporary because of low barriers to entry. Further, the improving profit margins in the industry have allowed smaller operators to expand considerably. The most aggressive of them is Spirit Airlines Inc. (SAVE), which plans to double its fleet size by 2017. Starting in spring of next year, the company has decided to operate low-cost non-stop flights in 10 new destinations in the U.S. along with seven locations in Latin America.

PeopleExpress is the latest addition to this list as the Virginia-based start-up intends to expand its services in 24 cities within the next five years. These ultra-low fare carriers are gaining popularity by providing economical fares to domestic travelers, thus gaining popularity among the low-end customers.

Likewise, another low-fare Brazilian carrier GOL Linhas Aereas (GOL) expects consolidation of strategy and improvement in products to help deliver better performance in 2014. GOL witnessed a surge in demand owing to the 2014 FIFA World Cup which drew supporters from all over the world to Brazil. The country will also host 2016 summer Olympics, which will further boost air traffic.

Moreover, over the last few months, the company has increased the number of cities served and inaugurated new terminals to ensure better service and convenience for passengers. Earlier, in 2014, the company struck a deal with European giant Air France-KLM SA which will allow the companies to better serve the 318 destinations across 115 countries they currently operate.

Meanwhile, after Spirit Airlines, low-cost carrier Virgin America recently made an impressive debut on Nasdaq under the symbol ‘VA,’ riding on the favorable conditions prevailing in the U.S. aviation sector.

Bottom Line

There are various factors that reinstate hope of investors in the aviation industry. Major outperformers in the industry are Southwest Airlines and Spirit Airlines with a Zacks Rank #1 (Strong Buy). We also uphold Zacks Rank #2 (Buy) stocks such as American Airlines and Alaska Airlines Group Inc. (ALK). Meanwhile, JetBlue Airways, Delta and GOL Linhas A currently carry a Zacks Rank #3 (Hold).
AMER AIRLINES (AAL): Free Stock Analysis Report
DELTA AIR LINES (DAL): Free Stock Analysis Report
GOL LINHAS-ADR (GOL): Free Stock Analysis Report
JETBLUE AIRWAYS (JBLU): Free Stock Analysis Report
SOUTHWEST AIR (LUV): Free Stock Analysis Report
SPIRIT AIRLINES (SAVE): Free Stock Analysis Report
UNITED CONT HLD (UAL): Free Stock Analysis Report


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