Delta Air Lines, which returned to profitability in the second quarter of 2022, saw fourth-quarter profit top analysts’ expectations.MIKE SEGAR/Reuters
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Airlines stocks have been battered by the COVID-19 pandemic and other turbulence, but are starting to take off again.
Pent-up demand is driving the leisure market, while business travel is recovering. And that has given a lift to U.S. Global Jets ETF JETS-A, the only exchange-traded fund (ETF) focused on the airline industry.
This quasi-active fund, which owns airlines, airports, aircraft manufacturers and related services, has gained 21 per cent so far this year versus 5 per cent for the S&P 500 index.
Frank Holmes, chief executive officer and chief investment officer at U.S. Global Investors Inc. in San Antonio, Tex., says his firm sees a soft landing in the economy, and that airlines will do very well in that environment.
“A lot of this rally is about the positive sentiment from the two-, five-, and 10-year bond yields coming down, and China reopening [from COVID-19 lockdowns],” he says.
“That has created a change in sentiment – that the industry doesn’t have a headwind, but a tailwind now.”
The airlines also have pricing power, Mr. Holmes says.
“Demand is there, and people don’t care about the price of a ticket still,” he adds. “They want to travel …after being locked up for two years.”
There is also an emerging trend in business travel, which comes from independent contractors who are younger and want to travel to warmer climates, such as the Caribbean, he says.
“They do business from wherever. They might write code or do data analysis on their laptop and send back reports,” he says.
The International Air Transport Association expects the global airline industry to return to profitability this year, with more than four billion passengers flying after an almost three-year downturn.
Airlines are expected to post a small net profit of US$4.6-billion – the first profit since 2019, when industry net profits hit US$26.4-billion, the industry body indicates.
Delta Air Lines Inc. DAL-N, which returned to profitability in the second quarter of 2022, saw fourth-quarter profit top analysts’ expectations. It forecasts 2023 revenue to grow by 15 to 20 per cent over last year, with a full-year outlook for earnings of US$5- to US$6-per share, and more than US$7 of earnings a share in 2024.
Mr. Holmes sees upside potential for Delta Airlines stock because it’s “so well run.” He also favours JetBlue Airways Corp. JBLU-Q, whose merger with Spirit Airlines Inc. SAVE-N, requires regulatory approval; Alaska Air Group Inc. ALK-N and Hawaiian Holdings Inc. HA-Q.
Still, higher oil prices are a big risk for airline stocks as well as “rising interest rates that would slow the global economy,” he acknowledges. But rates, he adds, appear to be peaking as “inflation has come down.”
However, in an airline industry report, Raymond James & Associates Inc. analyst Savanthi Syth says she expects a “demand contraction in the first half of 2023 without a meaningful pullback in fuel price, along with elevated cost pressures from still recovering networks [from COVID-19].”
U.S. airlines, in particular, are facing “significant wage inflation, with most airlines in our coverage still generating earnings,” and some continuing to generate free cash flow, Ms. Syth says.
“While we recognize that it is hard for stocks to work ahead of potentially negative news, we would recommend building positions on pullbacks, particularly across our current strong buy-rated picks,” she says.
Among U.S. airlines, she still favours Southwest Airlines Co. LUV-N, with a US$45-target despite its operational woes last month and Delta Airlines with a US$53-target price.
“We continue to see unique tailwinds for Delta versus legacy peers,” and they include a relatively low debt burden, a lack of hefty aircraft order book, and a balanced approach to capital deployment, she says.
Ms. Syth also has a strong-buy rating on Panama-based Copa Holdings SA CPA-N, with a US$125-target price, and Ireland-based Ryanair Holdings PLC RYAAY-Q, with a US$113-target.
Copa Holdings, which owns Copa Airlines, has a “robust balance sheet … and is one of the first airlines to start returning cash to shareholders, currently through buybacks, and we expect a more meaningful dividend in 2023,” she adds.
Ryanair Holdings, which is the largest European budget airline, also has a strong balance sheet.
Pent-up demand should offset headwinds
TD Securities analyst Tim James expects traffic to remain strong and pricing to be even stronger this winter after a much faster than anticipated return of air travel last year.
“Travel restrictions in Canada were lifted much later [in the second quarter of 2022] than most other developed markets, which means that pent-up demand was greater and that it started to drive airline revenue later than the U.S. and Europe,” he says.
“The revenue recovery is being driven by airfares as fuel and cost inflation combined with the post-pandemic, price-insensitive buying behaviour of passengers drive yields [ticket revenue generated per passenger flown one mile] higher.”
Pent-up demand should more than offset any economic headwinds in 2023, although “we anticipate that volume will take the lead from pricing in driving revenue,” he adds.
The recovery in high-margin business travel continues to lag leisure travel, he says. “We believe that it will eventually have to return to pre-2020 levels – from 70 to 80 per cent currently – to achieve a full recovery in profitability as leisure travel pricing cools and normalizes.”
While Air Canada AC-T and Chorus Aviation Inc. CHR-T, an aircraft lessor and owner of Jazz Aviation LP and Voyageur Aviation Corp., have moved beyond pandemic-related government support, “we think that the willingness of government to step in, and assist airlines during the pandemic … reduces the long-term risk profile of the sector,” he adds.
Mr. James has a buy rating on Air Canada with a 12-month target of $26 a share, and on Chorus Aviation with target of $5 a share.
For Chorus, there is long-term upside potential from its leasing business after partnering last year with Brookfield Asset Management Ltd. to acquire U.K.-based Falko Regional Aircraft Ltd., he adds.
However, he has a “reduce” rating on tour operator Transat AT Inc. TRZ-T because it “generates greater risk based on its historical margin profile, balance sheet and revenue mix.”
Air Canada scrapped its proposed $190-million deal in 2021 to acquire Transat after being advised by the European Commission that it would not approve the transaction.
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