Fuel costs and strikes threaten airline profits

While oil investors will be cheering the surge in prices, which has seen Brent and WTI clock up the most impressive 12-month performance across a range of asset classes, airline shareholders will be watching the rise with increasing concern. The International Air Transport Association (IATA) warned that jet fuel prices will likely increase by 25% this year, with a June report suggesting that profits for the year would be approximately $34 billion for 2018, from December’s estimate of $38.4 billion.

Tax credits and other one-off items boosted 2017 profits to $38 billion, but the rise in fuel prices will outstrip the forecast 7% rise in passenger numbers for the year, which is itself a weaker figure than that of 2017.

At the beginning of the year, airlines were seemingly content not to worry too much about hedging their oil exposure. However, first quarter (Q1) earnings from US airlines such as United Airlines and American Airlines said that fuel prices had risen around a quarter compared to the first three months of 2017. Higher oil prices tend to result either in higher ticket costs, or reduced utilisation of aircraft as flying hours are cut. Given the tight competition among airlines, no firm will want to be the first to raise prices.

But there is also another problem for the industry – industrial action. Indeed, this may have overtaken fuel prices as the major worry. One estimate of the cost from the wave of strikes across Europe comes from the European industry body A4E, which put the cost between 2010 and 2017 at $15.7 billion. Ryanair has reported that it cancelled over 1000 flights in May due to strikes, while International Airlines Group (IAG), owner of various airlines such as British Airways, is using up more fuel re-routing flights around French airspace.

This suggests a double punch from strikes, as revenue is hit by a cancellation of flights while profits are diminished by increased fuel consumption. IATA may well be forecast to reduce its profit expectations for 2019, should the wave of strikes continue.

It is not all bad news for airlines. IAG, despite having seen its share price double since 2013, still trades on a forward price to earnings (PE) ratio of just 7. A 10% annual rise in passengers in May suggests that growth will remain solid, and IAG’s position in both national flag-carriers like British Airways and budget airlines like Aer Lingus mean that it is well placed to benefit from growth in either or both of these segments. A 3.6% yield boosts the attractiveness of the shares

IAG shares found solid support around £5.75 during 2017 and early 2018, before rallying from March to new highs above £7.00. Buyers have come in to defend the £6.40-£6.50 area, so a recovery above £6.67 would suggest a move back to £7.13.