The airline sector can be a minefield for investors because there are at least two major problems airlines have to deal with in terms of growing profits: Fuel and labor costs. There are times when major airlines only have to deal with one of those issues, but when a carrier is grappling with both dilemmas at the same time, investors should stay away. Still, there are times, such as when the broader economy is thriving or oil prices sag, when the airline industry can deliver profits to investors.
Following A Recession
Airline stocks are highly sensitive to macroeconomic news and that makes these companies (and their share prices) vulnerable to economic downturns. Businesses cut back on travel expenses and leisure travelers take fewer vacations during recessions. Market timing is difficult, but airline stocks can be worth a trade or two following a recession. Not immediately after, but as economic data (consumer and employment numbers in particular) start to rebound, airline stocks often follow.
Falling Oil Prices
Arguably, no other industry is as beholden to oil prices as the airline business. Some airlines do hedge their oil exposure in the futures market. That means an airline will lock in barrels of oil at a set price for a few years into the future in anticipation of oil prices soaring. Not all airlines engage in that practice leaving themselves vulnerable to unforeseen spikes in oil prices. By some estimates, every time the price of oil rises $1 per barrel, it costs the global airline business $1 billion. All of that is to say when oil prices fall, shares of airlines often rise.
Buying a stock solely on the basis that it is rumored to be or could be in the future a takeover target is not practical investing. However, the U.S. airline industry has steadily consolidated over time. The number of major legacy carriers has fallen because it is more efficient for airlines to combine to gain new gates and routes while reducing labor costs while trying to do those things on their own. Investors that own shares of the acquired carrier usually benefit because the acquiring firm will pay a premium to make the deal happen.
Good For Active Traders
Given the negative correlation to oil prices and the highly discretionary nature of the business, airline stocks, broadly speaking, have tendencies to be volatile or high beta names. Those traits in stocks are coveted by active traders that can move in and out of positions within a single trading day or in just a few days. Said another way, airline stocks can be great trades, but lousy investments.
Todd Shriber is a financial writer who started covering financial markets in 2000. He worked for three years with Bloomberg News and specializes in analysis of stocks, sectors and exchange-traded funds. Shriber has a Bachelor of Science in broadcast journalism from Texas Christian University.