Major airline stocks including Delta Air Lines (NYSE:DAL) and American Airlines (NASDAQ:AAL) have been plummeting recently due to a variety of worries about global economic growth and geopolitical instability. They took another dive lower this week, following the first confirmed case of the Ebola virus in the U.S.
There is only one confirmed Ebola case in the U.S. at this point, as well as one or two other possible cases. Still, some investors are worried that this could become a repeat of the 2003 SARS outbreak in Asia that dampened international air travel and severely hurt U.S. airlines.
However, this is a much different situation. U.S. health officials remain confident that they have contained the spread of the virus. Even more important, major U.S. airlines like Delta and American are in a much better position to weather a temporary aviation downturn than they were in 2003.
Airlines were weak in 2003
Airlines began running into trouble in 2001, after the "dot-com bubble" burst, cutting into travel demand. The situation went downhill rapidly following 9/11. Many people were afraid to travel, security procedures became much tougher (and more inconvenient), and the economy fell into a recession.
As a result, the major U.S. airlines combined to lose more than $8 billion in 2001, according to the Bureau of Transportation Statistics. These losses ballooned to more than $11 billion in 2002. Congress had to provide a $15 billion bailout to the industry soon after the 9/11 attacks: $5 billion of direct aid and another $10 billion of loan guarantees.
Thus, airlines were already on the rocks coming into 2003. Several major airlines had either recently filed for bankruptcy or were on the verge of doing so. These carriers were counting on a rebound in air travel to return to profitability, but the SARS epidemic instead led to another downturn in travel demand.
Most airlines are on solid ground now
The airline industry environment could not be more different today. Numerous airlines are reporting record earnings. Delta Air Lines and American Airlines have led the industry recovery, and are on pace to earn roughly $4 billion each in adjusted pre-tax income.
They aren't alone. Several other U.S.-based airlines are on pace to post double-digit pre-tax margins in 2014 or 2015 (or in both years), whereas low single-digit margins were considered an accomplishment just a few years ago. Even the airlines that aren't quite up to this level are still consistently profitable with very few exceptions.
As a result, even if the Ebola situation were to worsen in the next few months, it wouldn't put any airlines on the brink of bankruptcy. Furthermore, epidemic fears don't usually have a long-term impact on air travel demand. Sooner or later, the epidemic is contained, and people return to their normal travel patterns.
What it all means
For long-term investors, this means that the Ebola-related airline sell-off is a buying opportunity. Ultimately, the value of Delta shares (to give an example) depends on the airline's competitive positioning within the airline industry, cost trends, and long-term economic growth. A brief air travel downturn won't impact any of these things.
In fact, among all their worries about Ebola and minor demand issues, investors appear to have overlooked a recent drop in jet fuel prices. The spot price for Gulf Coast jet fuel averaged $2.84 in August, but the price has fallen to the $2.65-$2.67 range as of last week.
This may seem like a relatively small change, but it's likely to have a much more significant impact on airline profitability than Ebola fears will. American and Delta each use about 4 billion gallons of jet fuel a year. Thus, they both stand to save hundreds of millions of dollars annually at recent fuel price levels.
The bottom line
A decade ago, airline investors had to worry about short-term demand shocks, because most airlines were permanently skating on the brink of bankruptcy. Today, airlines are well-prepared for almost any eventuality.
Ebola isn't a threat to the long-term profitability of companies like Delta Air Lines and American Airlines. As a result, the recent sell-off in airline shares -- motivated by short-term thinking -- is creating a nice opportunity for long-term investors to buy at a good entry price.