J.P. Morgan is hosting its Industrials Conference today and airlines are at an interesting cross section of competing factors.
On the upside, demand appears to be booming. Delta CEO Ed Bastian repeatedly highlighted strength in bookings.
“We are seeing strength in every market that we look at,” he said and emphasized that last week’s sales were up 25% year-over-year. This quarter the company had eight of the 10 best sales days ever and five of those came after the war started. The strong demand spans corporate, international, premium leisure, main cabin and domestic, he said.
On the downside, the jump in oil prices punched a hole in the company’s cost structure. Airline stocks have sunk since the start of the conflict as fuel typically represents 30-40% of costs. Bastian said the company has seen a $400 million fuel cost spike in just the month of March with American Airlines indicating the same size hit.
Despite that, DAL maintained its Q1 guidance of EPS of 50-90 cents. Shares are up 4.5% in the premarket.
There is a long history of airline companies seeing margins compress when fuel prices rise but it’s a bit more complicated than it first appears.
Oftentimes, the spikes in oil prices have come at the same times as economic weakness and that can be doubly-devestating for airlines but in other episodes of rising oil during a decent economy, the picture is less clear.
when a fuel spike is supply-driven but the economy is healthy, airlines absorb the hit through gradual fare pass-through (roughly 50% within a year based on Scotia’s AC data) and margins compress but stay positive. When a fuel spike coincides with recession, the pass-through mechanism breaks down because demand is falling at the same time costs are rising — airlines can’t raise fares into weakening demand — and the earnings destruction is multiplicative rather than additive.
In 2011, oil sustained $110–125 per barrel for several years, driven by the Arab Spring and Libyan disruptions. But GDP was growing, which kept load factors up and gave airlines some pricing power. Industry profits contracted massively but stayed positive in what was still a sluggish economy (but not a recession). Since then, we’ve seen some consolidation in US airlines.
The best parallel — if you believe the economy is ok — is likely 2018 when WTI rose 70%. Delta, United, and others actually grew earnings through the spike.
I tend to think this is an even better environment as travel is done mostly by those at the top of the K-shaped economy and that Boomers are traveling extensively in retirement (and will continue to) on high fixed incomes.
In response to Delta’s comments (and American Airlines affirming guidance), shares in the broader industry are all higher:
United +3.6%American Airlines +4.1%Southwest +2.5%IAG +2.4%Air Frace KLM +1.9%
This article was written by Adam Button at investinglive.com.