Can the Airline Industry Continue to Grow?

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Will we see continued growth in the airline industry or has it matured beyond capacity?

The airline industry has hit headlines in recent months, particularly when United dragged passenger David Dao violently off the plane and Qatar Airlines declared an interest in purchasing a 10% stake in American Airlines.

The airline industry is a mature market whose profitability largely sways with external factors like oil prices, the cyclical macro-economy, labor costs, and even the weather. Over the past five years, United Continental Holdings Inc. (NYSE: UAL) and American Airlines (NYSE: AAL) has hitched a ride with the strong bull market.

United stock has gained 212% in the past 5 years, recently at $76 from its all-time high of $82.03 on June 2nd. American Airlines, currently at $48.50, has gained 94%, if calculating point-to-point from December 10, 2013. Delta Airlines stock is priced at $52.84, which is very close to its all-time high of $53.04.

A booming economy is a pro-airline environment, as it generally increases the disposable income of middle-class families and frequent travelers, who are at the root of the industry’s revenue model. The price of jet fuel, which fluctuates with the price of crude oil, has decreased as crude oil has been depressed in recent months. This is because OPEC has been unable to agree on production cuts.

However, the airline industry faces limited ground-breaking innovation beyond existing transportation technology and strong competition domestically and internationally, where foreign airlines such as Qatar Airlines are accused of taking government subsidies to undercut U.S. airlines. Despite these factors for limited growth, crude oil depressions and severe cost-cutting measures have led to airline companies with healthier balance sheets. The question at hand is will we see continued growth or has the airline industry matured beyond its capacity?

In an industry that has brilliantly discriminated the prices of its services, the airline revenue model has seen minimal changes in the past years. In recent years, household names have continued to grow, and competition for loyal travelers have left airlines scrambling to offering discounts and more traveler miles.

Due to the bull market we’ve experienced in the past half-decade, rising labor costs negatively impact this industry’s bottom line. Airlines have not always been profitable as they are today. In the aftermath of the 2008 financial crisis, including the recession that followed, airliners have suffered losses that amounted to nearly $12.50 per share (United Continental).

This goes to show how consumer spending largely impacts airline profitability and revenues. Weaker family finances in bear markets result in less traveling and ultimately less corporate airline profits. On the other hand, the bull market of 2013, during which the S&P 500 grew 33%, facilitated a profitable environment which allowed airlines to post consistent EPS growth for the year and for the subsequent quarters.

The growth we’ve seen in recent years looks healthy for blue-chip stocks with long-term revenue prospects. Despite EBITDA falling short of peak levels seen in 2015, the cyclical aspect of the airline industry requires investor expectations to be set lower in times of a dwindling bull market.

Recent news of possible equity selloffs, increased volatility, and investor fear, and second-thoughts on the Senate’s ability to pass legislation leaves investors doubtful of seeing green on the screen for much longer.

The airline industry’s earnings are highly connected to the input costs that are involved. The combination of seasonal and cyclical spending behaviors, the increase in input costs in the years to come (crude oil won’t stay under $60 forever), and grueling competition that suppresses operating margins are factors that limit the growth potential for the airline industry.

However, limited alternatives to airline travel will keep the industry in business. Unlike cars, airplanes have a harder time running solely on alternative energy and renewable resources.

Without a company or technology to disrupt the airline industry down to its core, it seems as though it is here to stay and dominate. If airlines continue to cut down unnecessary costs and figure out a way to attract loyal customers without aggressive discounts, the industry has the chance to reward shareholders with long-term value.

Aaron Choi is a student at New York University's Stern School of Business.

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