Insights

Why Airline Stocks Lost Altitude This Week

What happened

Fears are growing that the U.S. economy is flying toward a recession, and airline stocks are losing ground, as a result. Shares of Delta Air Lines (NYSE: DAL), United Airlines Holdings, American Airlines Group, Southwest Airlines (NYSE: LUV), Alaska Air Group, JetBlue Airways, and Hawaiian Holdings were all down 12% or more for the week, as of close of business Thursday afternoon.

So what

For airline investors, 2022 is not living up to the high expectations Wall Street had heading into the year. After nearly two years of reduced demand due to the pandemic, air traffic was supposed to rebound heading into the summer, which investors hoped would lead to strong profits and help the industry pay down some of the debt taken on during the downturn.

The summer travel demand has arrived, and planes are flying full, but higher costs have been the real story of 2022 so far. A scarcity of pilots is limiting the ability for airlines to grow and putting pressure on labor costs, and the war in Ukraine has caused fuel prices to spike. It all means that airlines are seeing more revenue come in the door, but the higher expenses are offsetting the gains and causing margins to remain flat.

The airlines are also juggling summer flight cancellations, usually triggered by weather but compounded by the pilot shortage.

With all the issues the airlines are facing, the last thing they need is for that revenue boost to come under threat. But that’s exactly what investors are worried might happen. With inflation surging, households focused on tightening their belts are probably going to be less likely to make big-ticket discretionary purchases, like airplane tickets. And markets are worried that the Federal Reserve’s battle to fight inflation could send the U.S. economy into a recession, which would likely cut into demand for both leisure and business travel.

Given all the uncertainty, the airlines fell more than the broader markets on what has been a dreary week on Wall Street.

Now what

For a long-term focused investor, there’s a bull case to be made for airline stocks. A round of consolidation completed nearly a decade ago has left the industry much more stable than in years past, which is part of the reason the U.S. carriers were able to navigate the pandemic shutdowns without ending up in bankruptcy. With the “big four” of Southwest, American, United, and Delta controlling more than 80% of the domestic market, there’s a reasonable expectation for pricing power in the years to come.

But anyone who buys in today has to really take a long-term perspective, as it’s possible it will be the second half of the decade before the industry fully recovers from its pandemic woes. And if the first half of 2022 has taught us anything, it’s that there’s a lot that can go wrong with even the best laid plans.

For those willing to buy in, Delta and Southwest appear to be the best choices. Southwest has long been the industry leader and has a reputation for nimbleness that will likely serve it well in the years to come. Delta is the pioneer behind some of the changes in the industry over the past year that has created a more profitable and investible group of companies. It also has a balance sheet that should allow it to be among the first carriers to fully recover.

Lou Whiteman has positions in Delta Air Lines. The Motley Fool recommends Alaska Air Group, Delta Air Lines, Hawaiian Holdings, JetBlue Airways, and Southwest Airlines. The Motley Fool has a disclosure policy.

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