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Take that vacation this summer – but don’t buy these Airline stocks

Take that vacation this summer – but don’t buy these Airline stocks

Ah, summer – that wonderful period when the kids don’t have to go to school, and the entire family can plan a nice, relaxing getaway, getting out of the house and out of town to visit interesting places near or far. Recent reports suggest that while it may a great time to go ahead and plan that vacation, if you haven’t already booked your airfare, you’ll have to pay extra this year.

Blame the rise in crude prices. While the spread between Middle Eastern (Brent) and West Texas Light (TWI) is wider than it’s been in three years, both commodities are up in a big way over the past year. In June of last year, Brent found a bottom at around $44 per barrel before OPEC production cuts finally took hold and stabilized that price. As of yesterday’s close, it is above $77 per barrel. The pattern in WTI is basically the same, bottoming at around $42 per barrel in June 2017 before rising to a current price just a little below $66. That’s a 75% increase in price for Brent, and 57% for WTI. For U.S. airline stocks, that means that one of the most critical costs they have to contend with is taking a big bite out of their bottom line.

In April, the CEO of American Airlines (AAL) told analysts to expect fares to go higher, because airlines of themselves can’t afford to simply absorb that higher cost. This is a cost that, the longer it remains high, will inevitably pass through to the consumer. This week Delta Airlines (DAL) reported their fuel costs were up 50% for the year and 12% over the last three months. While it is possible that consumers could simply choose to absorb that cost – if air traffic this summer remains high, for example – the more likely result is that sales will drop and more consumers will choose to adjust their plans for vacation destinations closer to home. 

Considering the limitations of infrastructure the U.S. is dealing with in bringing crude to market right now – new pipeline and storage projects aren’t expected to be ready until late 2019 or even 2020, and the generally high demand that exists globally, it doesn’t seem like crude is going to be likely to drop back to more affordable levels. I think that makes airline stocks in general a risky bet for the foreseeable future. Considering the current difference in the Brent/WTI spread, I also think that risk is more elevated for airline companies with global operations than it is for those that generally don’t stray far away from the American hemisphere.

Here are three U.S. airline stocks that I think have a higher level of risk exposure than the rest of the industry.

American Airlines Group Inc. (AAL)

Current Price: $43.06

AAL’s primary business activity is the operation of a network air carrier, providing scheduled air transportation for passengers and cargo. The Company operates through American segment, which provides air transportation for passengers and cargo. The Company’s cargo division provides a range of freight and mail services with facilities and interline connections available across the globe. Together with its regional airline subsidiaries and third-party regional carriers operating as American Eagle, its airline operated an average of nearly 6,700 flights per day to nearly 350 destinations in more than 50 countries, principally from its hubs in Charlotte, Chicago, Dallas/Fort Worth, Los Angeles, Miami, New York, Philadelphia, Phoenix and Washington, District of Columbia. In the fiscal year ended December 31, 2016, approximately 199 million passengers boarded its mainline and regional flights.

Of the three stocks in my list, AAL is the most discounted based on its recent price activity. It hit a 52-week high at around $59 in mid-January. The broad market’s correction that began took the stock to as low as $48 in early February before it bounced back up to about $56. It then resumed its downward spiral and has been hovering between a trend low at $42 and just a little below $45 since then. From a technical standpoint, that might look attractive for a trend or swing trader, but given the cost pressures from increasing fuel prices and the fact that the stock is currently trading more than 30% above its historical average Price/Earnings multiple, there is significantly more downside risk right now than there is upside potential.

Delta Air Lines Inc. (DAL)

Current Price: $53.59

DAL provides scheduled air transportation for passengers and cargo throughout the United States and across the world. The Company’s segments include Airline and Refinery. The Company’s route network is centered around a system of hub, international gateway and airports that the Company operates in Amsterdam, Atlanta, Boston, Detroit, London-Heathrow, Los Angeles, Minneapolis-St. Paul, New York-LaGuardia, New York- John F Kennedy International Airport, Paris-Charles de Gaulle, Salt Lake City, Seattle and Tokyo-Narita. Each of these operations includes flights that gather and distribute traffic from markets in the geographic region surrounding the hub or gateway to domestic and international cities and to other hubs or gateways. The Company’s route network includes its international joint ventures, its alliances with other foreign airlines, its membership in SkyTeam and agreements with multiple domestic regional carriers that operate as Delta Connection.

DAL has been hovering in a price range since December of last year, with range resistance in the $57 price area and support around $51. The one outlier was a two-day break in early January that pushed the stock to a 52-week high as $60 per share that it couldn’t hold; it dropped overnight late that month back into the range I’ve just mentioned. Since April, that range has narrowed, with a high at around $55, with the same support low at around $51.

From a fundamental standpoint, the downside risk for DAL is probably not as elevated as with AAL, since the stock is actually about 20% below it’s historical Price/Earnings ratio right now. It is only marginally below its historical Price/Book ratio, however, which I believe is a better way to measure long-term upside potential. Considering the effect of higher fuel prices for the foreseeable future, I would prefer to wait to see DAL settle into a range 20 to 30% below its historical Price/Book ratio, with indications that costs have leveled off before looking for any real opportunity here.

United Continental Holdings (UAL)

Current Price: $69.69

United Continental Holdings, Inc. (UAL) is a holding company and its principal subsidiary is United Air Lines, Inc. (United). The Company transports people and cargo through its mainline operations. It has global air rights in North America, Asia-Pacific, Europe, Middle East, Africa and Latin America. The Company, through United and its regional carriers, operates flights from its hubs at Newark Liberty International Airport (Newark Liberty), Chicago O’Hare International Airport (Chicago O’Hare), Denver International Airport (Denver), George Bush Intercontinental Airport (Houston Bush), Los Angeles International Airport (LAX), A.B. Won Pat International Airport (Guam), San Francisco International Airport (SFO) and Washington Dulles International Airport (Washington Dulles). It has contractual relationships with regional carriers to provide regional jet and turboprop service branded as United Express. These regional operations are an extension of the Company’s mainline network.

The technical picture for UAL is the most favorable for a breakout of the three stocks in this list. Like DAL, the stock has been hovering in a narrow range between $66 on the low side and $71 on the high side. The range appears to be narrowing over the last couple of weeks, with resistance in the same $71 range, but support rising to about $68 per share. Technicians like to compare that tightening range to the increasing tension of a coiled spring; the more tightly you wind the spring, the more likely it is to spring back to its natural state with great force. The implication is the stock could be poised for a significant breakout.

There is also a better fundamental argument to make for UAL to drive to higher prices than the other two stocks in this list. The stock is trading about 40% below its historical Price/Earnings ratio, but I think that is balanced by the fact that it is also only marginally lower than its historical Price/Book ratio. Overall, I think UAL will be as vulnerable to the rest of the industry to the impact of higher fuel costs, so if the stock’s narrowing range suggests a breakout is imminent, it is more likely to happen to the downside.

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