Zacks Industry Outlook Highlights: Delta Airlines, GOL Linhas and United Continental Holdings

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Nov 26, 2014, 09:30 ET

CHICAGO, Nov. 26, 2014 /PRNewswire/ -- Today, Zacks Equity Research discusses the Airlines (part 1), including Delta Airlines Inc. (NYSE:DAL-Free Report), GOL Linhas A (NYSE:GOL-Free Report) and United Continental Holdings Inc. (NYSE:UAL-Free Report).

Industry: Airlines (part 1)

Link: http://www.zacks.com/commentary/35570/airline-stocks-soar-fuel-costs-offset-ebola-scare

The global aviation industry retained its strong momentum even in the recently concluded third quarter of 2014 on declining fuel prices, rising passenger travel demand and growing cargo and passenger traffic. Despite the outbreak of Ebola virus, most airline companies were able to maintain impressive air traffic growth in the recent months, resulting in an optimistic outlook for the remainder of 2014 and beyond.

Fuel costs comprise nearly 30% of the total operating expenses incurred by airline companies. Since June this year, crude oil prices have gone down by 30% which has translated into the impressive profits garnered by airline stocks in the third quarter.

According to the International Air Transport Association (IATA), expansion of the economic cycle along with rapid Gross Domestic Product (GDP) and world trade growth are expected to boost air travel by 5.9% − the best since 2011. The rise in capacity may, in turn, lead to a 3.5% cut in airfares, thus benefiting travelers.

The IATA remains positive on the industry and projects overall airline profits of $18.0 billion on revenues of $746 billion for 2014, from an estimated 3.32 billion passengers. In 2014, net profit margin is projected at 2.4%, up from 1.5% in 2013. The industry is expected to generate $5.42 from every departing passenger on an average, a rather soft number for a high-risk business.

Additionally, air cargo volumes -- a crucial indicator of business confidence -- have been a trouble spot since 2010. However, figures have been recovering since the start of 2014 and could expand 3.1% in the course of the year to reach $197 billion.

Outlook for North America

North America: With an improvement in the world's largest economy, airlines in North America have seen considerable opportunities in 2014. Consolidation benefits, rising travel demand and several new and enhanced ancillary revenues provide an impetus to growth.

Better days are ahead for the U.S. airline industry with Airlines for America (A4A) predicting a 1.5% increase in the number of flyers during the Thanksgiving holiday season this year. According to the forecast, U.S. airlines will transport 24.6 million passengers in the Nov 21–Dec 2 period. Nov 30, the Sunday after Thanksgiving, is expected to be the busiest flying day in the period under consideration.

To tap in on the holiday season opportunity, most domestic airline companies in the U.S. have decided to maximize profits by increasing fares and seats. Recently, Delta Airlines Inc. (NYSE:DAL-Free Report) hiked round-trip fares by nearly $10 and was well followed by other leading carriers. Likewise, to boost revenue during the holiday season, JetBlue has also decided to charge bag fees and squeeze seats.

The recent agreement between the U.S. and China governments, to extend the validity of short-term visas for visitors between both nations for up to ten years followed with the extension of student exchange visas from one to five years will considerably benefit airline companies while going forward.

Although performance will continue to vary substantially between different U.S. carriers, a strong 2013 has made way for a higher 2014 profit forecast of $9.2 billion.

Underlying Factors for 2014 Profits

There are several catalysts that are poised to trigger profits for the overall airline industry in 2014 and beyond. These include:

Passenger & Cargo: The IATA suggests that economic recovery along with faster GDP and world trade growth will drive air transportation demand. Customers, on the other hand, will benefit from cheaper air travel as one-way fares are expected to be slashed by 3.5% this year. The association projects global airline passenger growth of 5.9%. Meanwhile, the average industry load factor is expected at 80.4%.

Coming to demand-supply balances, demand (measured in traffic) is expected to outpace capacity in 2014. While the projected capacity increase is pegged at 5.5%, air travel demand is likely to see a 5.9% pickup.

Fuel Price Effect: Airline profits largely depend on fuel prices, the major variable component in the industry. For 2014, average jet fuel prices are expected to stay at $122.9 per barrel, a notch lower than $124.5 per barrel in 2013. However, oversupply of crude oil in the market has resulted in the downward trend in jet fuel prices, reaching price levels much below the forecasted price which is currently hovering near $100 a barrel. The association also expects fuel costs to remain stable at around $212 billion in the remainder of 2014.

Fleet Restructuring: Air carriers at large are looking for fuel efficient fleets in order to reduce costs that have gained 55% over the period 2006–2013. Most airline companies have set long-term goals of replacing aging planes with new and upgraded ones. Volatile oil prices have also played a major part in the fleet replacement decision. In a bid to retire depleted aircraft, recently Delta Airlines has recently ordered 50 new jets from Airbus worth $14 billion, to be delivered between 2017 and 2019. Even, Brazilian carrier GOL Linhas A (NYSE:GOL-Free Report) plans to invest nearly $1.7 billion to buy small, single-aisle jet models from Boeing Co. and Embraer SA.

According to Boeing, over the next 20 years, global airlines are expected to invest around $5.2 trillion in fleet development. Over the long run, the carriers aim to replace old narrow-body jets -- A320's/B757-200/300 -- with advanced ones such as A-321, A320 Neo and the B737 Max, for better service and demand-supply equilibrium.

Jet Renovation: With passengers demanding comfort and quality service along with proper security, airlines are increasingly focusing on aircraft redesigning with the inclusion of new and attractive products and services within the travel plan. Meanwhile, United Continental Holdings Inc. (NYSE:UAL-Free Report) is offering premium flat-bed cabin seats on every long-haul international flight.

Further, the carrier has installed in-seat power on more than half of its mainline fliers and has paced up the installation of the satellite-based first ever Wi-Fi service for fliers. Delta Airlines plans to invest $750 million over the next two-year period to deploy Wi-Fi as well as to refurbish the interiors of its narrow-bodied aircraft over the next three years.

Apart from offering mini iPAD to its in-flight crewmembers to improve passenger service, the company will also extend its Porsche service to premier customers of three additional airports by Nov 30, 2014. Recently, JetBlue also launched its version of premium service, Mint, between JFK Airport, NYC and San Francisco International Airport.

Hedging Strategies: Hedging strategies are frequently used by airline companies to cope with rising fuel prices. Notably, carriers use a combination of calls, swaps and collars at varying WTI crude-equivalent price levels to hedge.

Zacks Industry Rank

Within the Zacks Industry classification, airlines are broadly grouped into the Transportation sector (one of the 16 Zacks sectors).

We rank all the 260-plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry. To learn more visit: About Zacks Industry Rank.

As a point of reference, the outlook for industries in the top one-third of the list (with Zacks Industry Rank #88 and lower) is 'Positive,' the mid one-third of the list (between #89 and 176) is 'Neutral,' while the last one-third (#177 and above) is 'Negative.'

The Zacks Industry Rank for the airline industry is currently #48, implying that the outlook remains positive on this sector for this year owing to a rise in passenger air travel demand.

Earnings Trends

The broader Transportation sector reflects a stable growth pattern. So far, 100% of the sector participants in the S&P 500 index have reported third-quarter results, which have been fairly good in terms of growth rates and beat ratios.

Total earnings for these companies are up 10.4% on 6.6% higher revenues, with 81.8% of the companies beating earnings estimates and 72.7% coming ahead of revenue expectations. This marks a much better performance by the Transportation sector than in any other recent quarter.

Third-quarter 2014 earnings are expected to rise 13.6%, thereby pegging the full-year 2014 growth outlook at 15.2%. For 2015, the sector's earnings are poised to expand around 17.2%.

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