By Susan Carey
Aug. 18, 2015 7:47 p.m. ET
U.S. airlines are producing their biggest profits ever. But instead of clear skies, they are encountering problems that their recent prosperity, in some cases, is making worse.
Employees at Southwest Airlines Co. and Delta Air Lines Inc. have rejected labor contracts in recent weeks, with some arguing that the compensation wasn’t sufficient given the industry’s financial performance. Federal regulators have started two separate probes into whether the biggest airlines have violated competition rules. And shareholders, fretting that the airlines’ success will stall, have beaten down stock prices.
“The airlines are probably doing the best jobs running their businesses in the history of the industry,” said Jim Corridore, equity analyst for S&P Capital IQ. “At the same time, they’re being attacked from many sides.”
Airlines have benefited from years of restructuring and consolidation, a tighter focus by management on profitability, and a roughly 55% drop since mid-2014 in the price of oil, which has gone from the industry’s biggest cost to its second biggest after labor.
U.S. airline earnings collectively topped $8 billion in the first half of this year alone. The companies have announced plans for large share buybacks, are repairing balance sheets and investing in their products.
Planes are also fuller than ever. Airlines for America, a trade group, has predicted an all-time high for summer travel, and this week forecast 14.2 million passengers will fly over the Labor Day period, up 3% from a year ago. The busiest day is expected to be Friday, Sept. 4.
However, it is what passengers are spending on fares and extras that is spooking investors.
Costs have dropped sharply for airlines, pushing profits higher. But a decline in ticket prices has hurt the companies’ unit revenue, which measures the amount of money taken in for each passenger flown a mile. Investors remain fixated on that metric, which has slumped this year and may not turn around until 2016. They are watching for signs that airlines are responding to better times by over expanding, setting up another downturn.
American Airlines Group Inc. shares have fallen about 19% so far this year, and United Continental Holdings Inc. stock is down 12.5%. Delta has dropped about 4% and Southwest shares have fallen 5%, while those of discounter Spirit Airlines Inc. have tumbled about 17%.
The shares of big European carriers such as Deutsche Lufthansa AG have also fallen sharply this year even as oil prices declined, with low-cost carriers such as Ryanair Holdings PLC keeping the lid on ticket prices by ramping up their own expansion plans across the Continent.
A few U.S. airlines have bucked the trend, including Alaska Air Group Inc., up about 35%, and JetBlue Airways Corp. , up about 52%, for reasons particular to those companies.
David Cush, chief executive of startup Virgin America Inc., said he understands investor skepticism, “given the history of the industry. But the skepticism seems to be larger than it should be, at least at these multiples.” Airlines are trading below those of industrial stocks or the S&P 500. “The valuations don’t reflect reality right now,” he said.
When American last month reported record profit of $1.7 billion, it also doubled its share-repurchase plan to $4 billion—something investors generally cheer. But its stock fell. Analysts peppered management on a conference call about what American is doing to bolster unit revenue to keep margins from shrinking.
“Look, the market will do what the market will do,” said CEO Doug Parker. “If it continues...to have this view, that will just allow us the opportunity to purchase more stock.”
Mr. Corridore, the S&P Capital IQ, says airline stocks broadly doubled in value in 2013 and then again in 2014. All the positives in the industry’s Renaissance—balance-sheet repair, strong cash generation, debt repayment, share buybacks and dividends—already have been priced in, he said. “We think investors are in a fear cycle right now” because the industry is growing faster than demand and that is putting pressure on unit revenues.
Meanwhile, airline workers have been pushing for bigger pieces of the enlarged pie than even their leaders have recommended. Both Southwest’s flight attendants and Delta’s pilots last month overwhelmingly rejected tentative agreements that union leaders endorsed as industry-leading. Southwest said it was disappointed with its contract vote. Delta didn’t comment.
Some labor leaders have attacked airlines’ cash returns to shareholders. Capt. Jay Heppner, the pilot union chief at United, complained in a message to his 12,500 members that the company’s new $3 billion share buyback “signals to investors that...management cannot think of anything better to do with its excess cash” while the 84,000 United employees “are doing the best we can with the limited tools and training we receive.”
Capt. Heppner, chairman of the leadership council of the Air Line Pilots Association, sits on United’s 13-member board. He declined to discuss board matters. United declined to comment.
Analysts worry that rising wages are another risk to rofitability. “The labor forces...see record results driven by lower fuel and are asking for significant wage increases,” said Helane Becker of Cowen & Co. “This could be peak earnings for the group and if that’s the case, labor could be hugely disappointed when their increases disappear.”
Then there are the regulatory inquiries. The Justice Department last month said it was investigating whether the four biggest—American, United, Delta and Southwest—are illegally signaling to each other their plans to limit capacity, which could help them raise fares. Weeks later, the Transportation Department said it was looking into complaints that the four, plus JetBlue, engaged in price gouging after an Amtrak derailment in Philadelphia in May briefly shut down rail service in the busy Northeast corridor.
The airlines have said they are cooperating with the investigations. Most have said they expect the probes to find no wrongdoing and some such as American’s Mr. Parker have said their companies have done nothing illegal.
Virgin America’s Mr. Cush, a former longtime executive at American, believes the Justice Department investigation is “about the structure of the industry” now that consolidation has put more than 80% of domestic capacity into the hands of four large carriers. “I personally believe we have not seen the worst of consolidation yet in terms of the impact on the marketplace,” he said.
But many analysts don’t believe the inquiries will find illegal behavior.
“I think these...things are going to blow over,” said Mr. Corridore. But, he said, they are creating another “cloud” over the industry.
One cloud remains the outlook for international travel. U.S. carriers have been diverting planes from some trans-Atlantic routes with too much capacity to add flights in domestic markets. The International Air Transport Association warned this week that slowing economic growth in Asia may be starting to turn into weaker business for the airlines. Airlines for America said Monday that the devaluation of the yuan could lead some U.S. carriers to trim their China schedules.
Original article can be found here: http://www.wsj.com
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