Market Overview

How The Airline Industry Is Slowly Morphing Into An Attractive Investment Opportunity

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On the heels of a devastating string of hurricanes, the airline industry has so far managed to weather the storm, a feat rarely associated with this industry. Major US carriers seem to have braved what has become the eighth-most active hurricane season in history, with most of them taking a positive outlook after the battering they’ve received over the past few months.

During an investor update earlier this month, American Airlines (NASDAQ: AAL) reported that it had lost about $75 million in pre-tax earnings as a result of hurricanes Irma, Harvey, and Maria. However, the airline said it still expects to register improvements in total revenue per available seat mile (TRASM) of up to 1.5% compared with the same period last year.

Delta Airlines (NYSE: DAL), which canceled more than 2,200 flights last month due to the effects of Hurricane Irma, also saw a marginal increase in domestic and group traffic at 0.3%. This is despite customer waivers, capped airfares, and a $1.75 million donation to the Red Cross.

The current resilience of the $1.5 trillion airline industry is one of several positive trends that are helping draw a picture of an industry on the mend. The industry is currently enjoying one of its longest streaks of financial stability in decades, a fact that informed Warren Buffet’s decision to invest $10 billion in an industry he once called a “death trap” for investors.  

For decades, the US airline industry had been a minefield for investors. Bankruptcies, high operating costs, vulnerability to exogenous events, and the industry’s knack for poor service and hassles had turned a lucrative environment for investors into the death trap that kept Buffet and other investors away for years.

But in recent times, there have been signs that things are changing for the better. There are fewer unsold seats, improved capacity management, and labor costs have been put under control by stakeholders within the industry.

Perhaps the biggest sign has been the wave of mergers and acquisitions within the US airline industry that has helped to redefine its landscape. Because the consolidation meant that the major airlines – American, Delta, United Airlines (NYSE: UAL) and Southwest Airlines (NYSE: LUV) – controlled about 80% of the industry, airlines are now better placed to control the dynamics of the industry by working as a form of oligopoly.

In fact, Charles Munger, Berkshire Hathaway Inc (NYSE: BRK.A) Vice Chairman and Buffet’s right-hand man was quoted by Bloomberg comparing the airline industry to the once problematic railroad industry.

“It was a terrible business for about 80 years. But finally they got down to four big railroads and it was a better business. And something similar is happening in the airline business.”

Plus, with crude oil prices struggling to go above $55 for most of the year, jet fuel prices have been contained at levels that have allowed airlines to stay profitable. Cheaper and stable fuel prices have enabled airlines to rein in the runaway operational costs that had plagued airlines and made the industry synonymous with bankruptcies over the past decade.

Airlines are also benefiting immensely from the use of technology to help chart clearer paths in the sky. A few years ago, Congress pumped more than $83 million into the National Weather Service to help with tech upgrades at the meteorology agency. As a result, the agency is able to provide more accurate storm forecasts, which enable airlines to plan ahead and reduce the financial impact of such storms.   

But while consolidation and low fuel prices have helped transform the industry into an efficient, well-oiled machine, it has also resulted in reduced competition, a fact that has given airlines the leeway to play around with airfares and fees – sometimes to the disadvantage of passengers.

Even worse, the higher airfares and fees haven’t translated into better customer service for passengers – the other problem that has plagued the industry. Earlier this year, United Airlines was on the receiving end after a series of customer service blunders, including the famous violent manhandling of David Dao, the passenger who refused to give up his seat.

United also has one of the worst records for pet deaths in the industry, a trend that worries Min Lee, Senior VP of the online pet company, CertaPet. “If an airline can’t guarantee the safety of your pet during a flight, it makes no sense to take that risk,” she says. With more than 2 million pets taking to the skies every year, customer service blunders in this area can hurt the industry in the long run.

For now, however, airlines seem to be benefiting from consolidation, lower oil prices, and the high airfares and in-flight fees, a trend that should feel like a bittersweet pill for investors. As long as airlines continue to benefit from increased revenues from higher fees, they’ll most likely continue offering subpar customer experience because, after all, why fix it when it’s not broken?

In the end, the US airline industry will likely morph into a lucrative investment opportunity, with airlines such as Southwest and American Airlines promising rewards for patient investors. 

The preceding article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.

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