On Tuesday, airline stocks got a lift after United Airlines Holdings (UAL 1.62%) said that so far, at least, demand is holding up well in the face of rising inflation. On Wednesday, the focus shifted to fears over how long that can last. Shares of United, American Airlines Holdings (AAL 2.58%), and Spirit Airlines (SAVE -2.00%) all fell about 5%, and planemaker Boeing (BA -1.25%) also traded down by a similar amount.
As I said yesterday, these are volatile times to be investing in airline stocks. The sector took it on the chin during the early days of the pandemic, with airlines scrambling to remain liquid as demand fell to near-zero. Demand has recovered nicely so far in 2022, but now new concerns including higher fuel and labor costs and the impact of soaring inflation are weighing heavily on investors.
United remains upbeat, on Tuesday raising its outlook for second-quarter passenger revenue. As expected, costs are going up, too, but United held its margin guidance steady, implying that strong demand is creating enough pricing power to offset the higher expenses.
The question is how long that can last. On Wednesday, the markets sold off following weaker-than-expected earnings from Target. The results suggest that inflation is beginning to have an impact on consumer behavior. It seems likely that if penny-pinching is in order consumers are more likely to rethink a big purchase like a vacation, which could mean there is a limit to how much airfare prices can go up in the months to come.
A potential slowdown comes at a difficult time for Boeing as well. The company stumbled well before the pandemic: Its 737 MAX was grounded for 18 months after a pair of fatal accidents. Post-crash scrutiny has led to regulators taking a fresh look at other Boeing planes as well, leading to delays in its forthcoming 777 widebody update and a suspension of deliveries of its 787 Dreamliner.
Boeing's debt ballooned during the pandemic, when airlines stopped buying new planes to preserve precious cash, and the company's balance sheet recovery has been hindered by a lack of deliveries due to quality concerns. The prospect of consumers tightening their belts would make it less likely that airlines will rush to refresh their fleets in the quarters to come, perhaps further delaying a Boeing recovery.
The long-term bull case for Boeing and the airlines is similar, and it has a lot of credibility. Global demand for air travel is expected to grow by more than 2% annually over the next two decades. That's going to create a lot of demand for airlines, and the need for a lot of new airplanes.
The problem is in the timing. While those long-term catalysts remain intact, there is a lot of uncertainty on the near-term horizon. Airlines have booked fares through much of the summer, but there is no telling what might happen to demand come Labor Day if inflation remains elevated. Investors also need to factor in what has so far been a sluggish business fare and international recovery, which could be further dented should a new wave of COVID-19 cases arrive in the fall, as some predict.
Add in the damage done by inflation on the cost side, particularly when it comes to labor and fuel costs, and both the airlines and their most important vendor might be stuck in a circling pattern for a lot longer than investors anticipate.
For those interested in buying in and waiting out the headwinds, I'm partial to buying aircraft financing company AerCap Holdings over any individual airline or aircraft manufacturer. AerCap has seen a sell-off because it has planes operating in Russia that might be unrecoverable due to the war, but the company is well capitalized and remains a way to gain exposure to aviation growth trends without betting on an individual vendor.
For those who want to ride the airlines instead, buckle up and be prepared for significant turbulence up ahead.