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Airline Fares Just Plummeted -- or Did They?

By Adam Levine-Weinberg – Aug 21, 2015 at 1:20PM

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In spite of a recent report from the Bureau of Labor Statistics, airfare pricing seems to be stabilizing.

Airline fares recorded their steepest monthly drop in two decades during July, according to the Bureau of Labor Statistics. As CNBC reported, the BLS measured a 5.6% decline in airfares last month, bucking the broader trend of rising consumer prices.

This recent piece of news has put more pressure on airline stocks, holding them back despite the huge positive impact of the most recent oil price rout. Crude oil prices have fallen by about $16 per barrel since the beginning of July, creating a roughly $1.5 billion annualized profit tailwind for major global carriers like Delta Air Lines (DAL 1.77%).

The recent drop in oil prices hasn't helped airline stocks much. Photo: The Motley Fool.

However, this story serves as a cautionary lesson that you shouldn't believe everything you read. The BLS airfare data don't seem to match up to actual pricing conditions in the airline industry.

Perception vs. reality
The BLS statistics paint a picture of wildly fluctuating airfares in 2015. Just in the past few months, the BLS has reported a 1.3% decline in the average airfare in April followed by gains of 5.7% and 2% in May and June, respectively. As noted above, the BLS has now reported a stunning 5.6% decline for July.

While airline pricing does change from day to day, it would be very surprising if airfares were quite as volatile as the BLS depicts. It's important to recognize that the BLS data collection methodology may prevent it from getting a full picture of what's going on. Among other things, it excludes business trips (the top source of high-fare customers) and frequent flier point redemptions.

Fortunately, while many airlines have stopped reporting unit revenue on a monthly basis, some still do. They include Delta Air Lines, Southwest Airlines (LUV 1.53%), and JetBlue Airways (JBLU 0.63%). Let's take a look at the trends they have reported.

Where's the volatility?
As it turns out, there is no evidence of a sharply deteriorating unit revenue trend in airlines' recent results. At Delta, passenger revenue per available seat mile -- or PRASM -- decreased 5.5% year over year in May. For July, Delta reported a smaller PRASM decline of 3.0%.

At Southwest Airlines, PRASM declined 6% year over year in May. In July, revenue per available seat mile (a closely related metric) fell 1% year over year. The July figure was boosted by 2-3 percentage points due to Southwest's new, more lucrative credit-card deal. Even adjusting for that change, Southwest's unit revenue trajectory improved by at least 2 percentage points from May to July.

Southwest Airlines' unit revenue trajectory appears to be stabilizing. Photo: The Motley Fool.

Finally, for JetBlue, PRASM increased about 1% year over year in both May and July.

The bottom line is that the volatility in the BLS data isn't borne out by airlines' actual revenue results. If anything, the unit revenue trajectory has been improving somewhat in the past few months: not deteriorating.

Unit revenue pressure could get worse before it gets better as the end of the busy summer travel season makes it harder for airlines to fill extra seats. For example, Southwest Airlines recently offered surprisingly deep discounts on certain flights. That said, most airlines have trimmed their capacity plans for the fall and 2016 as PRASM has declined, which should ultimately contribute to a return to unit revenue growth.

No need for panic
For the past year, two incompatible narratives about airline pricing have managed to coexist. On the one hand, consumer advocates and regulators have complained that airfares and fees haven't fallen despite the big drop in oil prices. On the other hand, airline investors have been terrified of a loss of airline pricing power.

Volatile data such as that produced by the BLS over the past year has probably encouraged these two narratives to live on. Consumer advocates can find data points showing that airfares are still rising, while airline bears can find data suggesting that airline prices are crashing.

The truth is somewhere in between. Unit revenue has declined at almost every airline this year -- JetBlue has been the main exception -- but the impact has been more than offset by lower fuel prices. Moreover, airlines have reacted to the changing environment by cutting capacity growth plans in order to stem the trend of declining unit revenue.

The main thing for investors to keep in mind is that airlines are still behaving rationally. As long as fuel prices don't spike again unexpectedly, most airlines should continue to post big profits for the next several years. Considering the low valuations prevailing across the sector, this makes the airline industry one of the most compelling areas of the market for investors today.

Adam Levine-Weinberg is long January 2017 $17 calls on JetBlue Airways and long January 2017 $40 calls on Delta Air Lines, The Motley Fool has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

JetBlue Airways Stock Quote
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Southwest Airlines Stock Quote
Southwest Airlines
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Delta Air Lines Stock Quote
Delta Air Lines
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