Shares of the top three U.S. airlines -- American Airlines (NASDAQ:AAL), Delta Air Lines (NYSE:DAL), and United Continental (NASDAQ:UAL) -- all rallied during the second half of 2016. They got off to a slow start in 2017, though, as investors had to temper their expectations for a quick return to profit growth.
However, all three have come back into favor this month. American Airlines and United Continental shares have both rallied 12% in May, and Delta Air Lines is close behind with a 9% gain.
The main driver of this airline stock rally has been evidence of strong demand. However, airlines are also getting a lift from falling fuel prices.
Delta escapes April with a unit revenue gain
Delta Air Lines had a costly mishap in early April, as waves of thunderstorms in Atlanta forced it to cancel thousands of flights. It took days to get the airline's operations back on track, leading to lots of lost revenue.
On Delta's earnings call last month, company president Glen Hauenstein estimated that disruption from the thunderstorms would reduce April unit revenue by 2 or 3 percentage points. He stated that "the month of April may potentially still be positive" despite that impact.
Last week, Delta confirmed that passenger revenue per available seat mile (PRASM) rose about 1% during April. This suggests that the carrier still has a shot at hitting the high end of its forecast for 1%-3% PRASM growth this quarter.
Solid monthly reports from American and United
Earlier this week, American Airlines and United Continental followed with their own solid updates. Less than two weeks ago, American issued its initial forecast for the second quarter, which called for revenue per available seat mile (RASM) to rise 3%-5% year over year.
By the beginning of this week, it was ready to raise that forecast. American Airlines now expects RASM to rise 3.5%-5.5% this quarter. American also increased its margin guidance this week. It now expects to produce a 12%-14% pre-tax margin for the second quarter (up from an initial estimate of 11%-13%).
United Airlines hasn't updated its initial forecast that PRASM would rise 1%-3% in the second quarter. However, it reported a strong 7.4% jump in passenger traffic for the month of April. United increased its capacity by 4% last month, and its load factor (the percentage of seats filled with paying passengers) rose by 2.6 percentage points.
The big increase in passenger traffic suggests that United isn't seeing a measurable backlash from several recent highly publicized customer service gaffes. (That said, it's important to remember that most of United's tickets for April had been sold before its now-infamous passenger-dragging incident.)
Oil prices are falling, too
The recent airline stock rally can be traced primarily to these indications of strong demand. However, investors are also starting to give airlines "credit" for a recent drop in fuel prices. As recently as the middle of April, the market price of jet fuel was $1.57 per gallon. By the beginning of May, the price had fallen to $1.41 per gallon, and it has continued to decline since then.
American Airlines, Delta Air Lines, and United Continental each use about 4 billion gallons of jet fuel per year, so a mere $0.16/gallon drop in the price of jet fuel can boost their annual profits by hundreds of millions of dollars (all else equal). Indeed, lower fuel prices contributed to American Airlines' increased margin forecast for Q2.
Oil prices can be quite volatile, so it's entirely possible that fuel prices will start rising again soon. However, if fuel prices stay low for the rest of the year, airlines should be able to follow up their record-setting 2015 and 2016 performances with another year of strong profits in 2017.