Zacks Industry Outlook Highlights: American Airlines, Bristow Group and Copa Holdings

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Dec 02, 2014, 09:30 ET

CHICAGO, Dec. 2, 2014 /PRNewswire/ -- Today, Zacks Equity Research discusses the Airlines, part 3, including American Airlines Group (Nasdaq:AAL-Free Report), Bristow Group Inc. (NYSE:BRS-Free Report) and Copa Holdings SA (NYSE:CPA-Free Report).

Industry: Airlines, part 3

Link: http://www.zacks.com/commentary/35651/airline-industry-will-current-headwinds-persist

The airline industry has been benefiting from an extremely favorable macro backdrop lately, ranging from improving demand for passenger and freight services to lower oil prices. The industry has also exhibited an unusual level of capacity discipline that has helped sustain pricing levels.

No doubt, the airline industry has been a star performer this year, with the industry in the S&P 500 index up an impressive +55% year-to-date period, handily beating the +12.3% gain for the index as a whole in that time period.

Given the industry's performance thus far, it is reasonable to infer that the best is likely behind us. There is no doubt that the low hanging fruit has been picked already. The industry is beset with perennial issue, ranging from exposure to fuel costs to geopolitical issues, regulatory burdens and labor strife that can come together mar the current happy environment.

Below, we discuss a few key factors which investors should take into consideration when investing in the airlines sector:

Challenges

Of the many challenges facing the industry, the most crucial ones are slow economic recovery, volatile fuel prices, natural calamities, industry consolidation, government regulation, unionization, airport infrastructure constraints, technological investments and safety concerns.

Pitfall of Industry Consolidation: Over the last few years, the U.S. aviation industry has been witnessing several consolidations with the most significant one being that of U.S. Airways with American Airlines in 2013. With major U.S. airlines joining forces, the total number of carriers operating within the industry is gradually decreasing. This has resulted in reduced competition, higher airfares and increased fees, thus affecting fliers.

Pilot Shortage: Lack of qualified pilots is disrupting airline operation particularly for the smaller carriers in some parts of the U.S., thus forcing them to keep aircrafts grounded. The Federal Aviation Administration's (FAA) ruling of hiring pilots with minimum of 1,500 hours of flying experience is being held as the root cause behind the shortfall in flight crew.

Oil Price Volatility: Fuel price volatility continues to be one of the most important challenges faced by the industry, as fuel costs are largely unpredictable. Further, geopolitical unrest continues to affect crude oil prices. Meanwhile, airline carriers fail to pass along the increased fuel costs to fliers owing to the competitive nature of the industry.

Unionization: The airline business is labor intensive. After fuel, labor expenses which include salaries and perks, tend to be the highest cost factor for carriers. Most of the employees are unionized and depend on various U.S. labor organizations which allow workers to maintain a high wage structure.

Moreover, the relation between airlines and labor unions are governed by the Railway Labor Act, which states that a collective bargaining agreement between an airline and a labor union does not expire and becomes amendable as of a stated date instead. Failure to conform to the revised terms and conditions may lead to work stoppages or strikes, thereby hampering operations.

As per the Bureau of Transportation Statistics (or BTS), the U.S. aviation group registered the ninth of successive annualized growth in scheduled passenger airline employment in Aug 2014. Full-time equivalent (or FTE) employees also grew 1% to 384,478 in the same month. Such robust growth in employee count may drive operating expenses in terms of salaries and wages going forward.

Recently, the integration process following the merger of American Airlines Group (Nasdaq:AAL-Free Report) and U.S. Airways Group Inc. suffered a major blow as flight attendants at American Airlines voted down a joint five-year labor contract.

Similarly, the airline industry in the rest of the world is also exposed to labor concerns -- apparent from the ongoing pension dispute between Aer Lingus and its largest trade union, which led to the former's reluctant approval to pump in additional funds to revamp its superannuation scheme. Moreover, Germany's Deutsche Lufthansa Aktiengesellschaft has also been witnessing strikes by pilots over cost cuts. The company also slashed its operating profit guidance for 2015 by around €1 billion.

In Sep 2014, pilots of Air France-KLM also went on a strike for two weeks. They thought that the French carrier will replace them with low-paid flyers.

Federal Regulations: The airline industry is highly regulated, in particular by the federal government. All companies engaged in air transportation in the U.S. are subject to the regulations implemented by the Department of Transportation (DoT). Further, airlines are also regulated by FAA, a division of the DoT, primarily in areas of flight operations, maintenance and other safety and technical matters. The new stringent pilot duty and rest rules under FAR117 will escalate expenses for carriers as companies will need to hire more pilots to comply with the new directives.

Previously, the FAA levied nearly $12 million fine on Southwest Airlines for non-maintenance of 44 Boeing 737 aircraft. Several such disputes with the FAA related to maintenance issues have persisted in the industry, creating an overall negativity.

Technological Failure: Technological investment is a key expense for air carriers. The profitability of airlines could be affected by technological glitches or failures to invest in upgrades. This may severely hamper services in general. In the first nine months of 2014, airline consumer complaints filed with Department of Transportation's (DOT) Aviation Consumer Protection Division rose 18.2% year over year.

Bottom Line

As evident from the above discussions, there are ample factors which sketch an unwelcoming picture of the airlines industry. In line with this, we expect Bristow Group Inc. (NYSE:BRS-Free Report) and Copa Holdings SA (NYSE:CPA-Free Report), to underperform the broader market with the companies holding a Zack Rank #4 (Sell) and a Zack Rank #5 (Strong Sell), respectively.

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