Oil prices spiked earlier this summer but have undergone a sharp decline to settle well below where they started the year. As oil prices have dropped, so have gasoline prices benefiting consumers and energy-intensive industries.
Among the biggest winners from this oil price slide is the airline industry, where cheaper jet fuel could set the stage for significant earnings increases.
A big expense
At around 30% of total expenses, jet fuel is one of the largest costs for airlines and is one they have little control over. According to Bureau of Transportation statistics, airlines spent over $48 billion combined on jet fuel last year and have already spent over $28 billion so far in 2014.
The significance of fuel expenses doesn't go unnoticed at airlines, with fuel cost per gallon being a routinely reported number in quarterly and monthly reports. Other strategies abound in the industry, including conventional strategies like hedging fuel prices through financial agreements and unconventional strategies like Delta Air Lines' (NYSE:DAL) move to buy an oil refinery.
Reducing fuel consumption has also been a major driver behind the modernization of airline fleets since newer aircraft are designed with fuel efficiency in mind. Considering the amount of cash airlines are spending on new aircraft to replace older planes still in working condition, airlines themselves clearly see fuel expense as an area deserving of attention.
In conducting daily flights, airlines use a lot of fuel, and even a small change in price can have a big impact on profits. The following table shows estimated 2014 fuel use by the four largest U.S. airlines with estimates used from each airline's 10-K filing from February. It also uses this data to estimate the savings for each $0.01 decrease in the price per gallon of jet fuel and its impact on earnings based on the current number of shares outstanding.
|Est. 2014 fuel usage||Saving per $0.01/ gal. decrease||Shares outstanding||Increase in EPS (pretax)|
|Delta Air Lines||3.9 billion||$39 million||843.0 million||$0.046|
|United Continental Holdings||4 billion||$40 million||373.6 million||$0.107|
|American Airlines Group||4.4 billion||$44 million||720.2 million||$0.061|
|Southwest Airlines||1.8 billion||$18 million||685.1 million||$0.026|
Since jet fuel prices are constantly fluctuating, it would be tough to come up with exact earnings impacts over long periods of time; however, these numbers are useful for comparing airline outlooks to those earlier this year.
All four major airlines are now well off their peaks, but the effects are strongest with Delta Air Lines and American Airlines Group, which will serve as the two examples in this comparison. In both cases, the market has given little credit for falling jet fuel prices while punishing shares on light news and market fears. I believe it's time to take a look at the value of lower jet fuel prices.
Delta Air Lines shares hit a high of $42.66 on June 5 but have since fallen about 13%. On June 5, jet fuel traded at $2.812 per gallon; $0.137 per gallon above the Sept. 29 price. On a full year basis, this drop should result in fuel savings of approximately $530 million or $0.63 per share.
Of course there are a lot of other variables here. Jet fuel prices will continue to fluctuate, Delta's fuel usage will not remain exactly the same, and Delta's fuel hedging program will result in extra costs or gains. But what is clear is that Delta should see a significant positive impact from this slide in jet fuel prices, and the market has not been rewarding the stock accordingly.
American Airlines Group fuel savings estimates should be a bit closer to actual savings since American does not engage in the same fuel hedging strategies as Delta. In American's case, its stock hit a high of $44.88 on June 23 and has fallen about 20% to today's levels. Despite jet fuel being a major cost to airlines, American Airlines Group shares hit their high as jet fuel prices neared their record high for 2014. On June 23, jet fuel traded at $2.954 per gallon; $0.279 per gallon above the Sept. 29 price. Using American's estimated fuel usage numbers, this drop would save the airline about $1.2 billion, or $1.67 per share, on an annual basis. Like in the Delta estimates, these are not exact numbers but they can serve as general impact estimates.
Based on the lack of major negative news, I continue to view the sell-off in airline stocks, particularly in American Airlines Group and Delta Air Lines, which have seen the biggest losses, as overdone. At the same time, jet fuel prices are now well below where they were trading as these airlines hit their highs in June. I believe this could create a major tailwind for earnings even as the market has sold off these stocks.
Although the typical risks of the airline industry still should be considered by investors, risk-tolerant investors should take a look at whether an investment here fits with their overall investment strategy. Personally, I will continue to remain long on American Airlines Group and Delta Air Lines, possibly increasing my positions if shares remain depressed.