Aircraft used to train astronauts are known colloquially as “vomit comets”. By climbing steeply and briefly levelling out before nosediving, the aircraft allow their passengers to achieve weightlessness. Investors in US airline stocks are undergoing a similarly giddy experience. Since reaching a low point on July 14, the Amex airline index has soared 100 per cent, illustrating the extent to which the sector has become an option on crude prices.
The industry’s latest quarterly numbers confirm an underlying precariousness. The year-on-year increase in the sector’s second quarter revenue covered only two-thirds of its incremental fuel bill, according to CreditSights. Even excluding fuel, unit costs rose slightly faster than unit revenue. Balance sheets are being frantically bolstered. Furthermore, the second quarter is typically strong for forward bookings, so cash will have enjoyed a seasonal boost.
In spite of the recent drop, the average crude price so far this year is 59 per cent above that of 2007. Even if oil slumped to $75 and stayed there until December 31, the year-on-year increase would be 37 per cent. Sector bulls hope capacity cuts will boost ticket prices to compensate. But the oil price is dropping for a reason: with US consumers under pressure and profitable transatlantic routes susceptible to a European slowdown and corporate cutbacks, that may not hold true. Demand is vulnerable and capacity cuts also raise unit costs.
In spite of doubling, the sector’s market capitalisation is still only $42bn, so volatility is virtually the only certainty equity investors have. The debt market, meanwhile, remains sceptical about the industry’s viability, with airline bonds still trading at deep discounts. There is little restructuring potential left following earlier bankruptcies, and these bonds remain well-collateralised. Sector enthusiasts should consider picking up distressed debt. Those buying into the equity rally, by contrast, could soon be reaching for the sick bag.