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Airline Stocks: High Risk, High Potential in Volatile Market

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Airline stocks have always been known for their rollercoaster-like price movements, making them a risky investment option for many. While there are times when airlines can outperform the market, the long-term trend shows that they often fail to generate consistent value and even underperform. In this report, we will delve into the factors that have been dragging down airline stocks not just in recent months, but over a broader timeframe. However, we will also highlight the potential value that exists within the industry.

What Holdings Are In The Jets ETF?

One way to gain exposure to airline stocks is through the U.S. Global Jets ETF (NYSEARCA:JETS), which holds a diversified portfolio of airline and travel-related companies. The ETF provides a global outlook, allowing investors to assess the expected performance of different regions within the industry. The top airline holdings in the JETS ETF include Southwest Airlines (LUV), Delta Air Lines (DAL), American Airlines (AAL), United Airlines (UAL), and more. It’s important to note that while the majority of the ETF consists of U.S. airlines, it also includes holdings in airlines from other regions, as well as airport stocks, OEMs, and other travel-related stocks.

US Global Jets ETF Structurally Underperforms With Glimpses Of Outperformance

The performance of the US Global Jets ETF has shown mixed results, with periods of both underperformance and outperformance compared to the broader markets. Since its inception, the ETF has shown a -36% performance compared to the market doubling. While the pandemic heavily impacted the airline industry, even pre-pandemic, airline stocks struggled to deliver consistent outperforming returns. Timing is crucial when investing in airline stocks, as their cyclical nature requires careful consideration.

Airline Stocks Underperformed Since The Boeing 737 MAX Crisis

In addition to their inherent volatility, airline stocks have been particularly affected by external factors such as the Boeing 737 MAX crisis. The crisis led to a significant decrease in the number of planes being delivered, forcing airlines to cut their schedules and impacting their profitability. The loss of potential profits due to the crisis was substantial, with airlines collectively losing billions of dollars. The recent settlement reached by Boeing also highlights the financial impact of the crisis on the industry.

Labor Costs Provide A Permanent Profit Pressure

The easing of travel restrictions post-pandemic has presented a new challenge for the airline industry – labor costs. Many employees left the industry during the pandemic, leading to a shortage of skilled workers. Coupled with a weakened supply chain for commercial airplanes, airlines are facing difficulties in efficiently capitalizing on the increased demand from customers. The shortage of labor, along with rising global energy prices and inflation, has resulted in a significant increase in labor costs for airlines. This cost pressure has negatively impacted the profitability of major airlines such as Delta and United.

What About Demand Strength?

While labor costs continue to rise, the strength of airline demand is also essential for their profitability. The shortage of airplanes and crews has contributed to strong demand and increased ticket prices. However, recent financial figures from major airlines show that the value generated by increased labor costs is declining. Unit revenues and yields are under pressure, indicating that the higher labor costs are being absorbed by the airlines rather than the consumers. The softening in unit revenues and stagnant yield may trigger a cost rationalization and further impact the profitability of airlines.

Oil and Turmoil Always Hit Airlines

Historically, oil prices and geopolitical turmoil have always had a significant impact on the airline industry. The recent increase in oil prices, combined with conflicts in the Middle East, has put further pressure on airlines. Higher oil prices directly impact the operating costs of airlines, reducing their profitability. Additionally, conflicts and terrorist attacks can dampen air travel demand, further affecting the industry’s performance.

Putting It Together Creates A High-Risk Cocktail For Airlines

When we consider the combination of rising labor costs, increasing oil prices, and the challenges in demand strength, it becomes evident that airline stocks are currently facing significant risks. The inflated labor costs, coupled with stagnant or declining unit revenues and yields, make it difficult to sustain profitability. While some airline stocks have shown positive returns, investors should be cautious and recognize the dynamic nature and slim margins of the industry. A prudent approach would be to handpick certain airline names with stronger performance and consider diversifying investments by including aerospace and defense companies.

The Big Mac Merger With Spirit Airlines and JetBlue

The possibility of consolidation within the airline industry has gained attention recently, with Spirit Airlines and JetBlue seeking to merge. The slim profit margins per passenger in the industry have prompted these companies to explore options to strengthen their position and improve profitability. However, legislative opposition to mergers and concerns about potential price increases have complicated these consolidation efforts. The need for consolidation in the industry remains clear, but the anti-consolidation sentiment observed among lawmakers adds to the challenges faced by airline stocks.

There Still Is Value in Airline Stocks

Despite the risks and challenges outlined, there is still value to be found in airline stocks. The industry has seen improvements in profitability and balance sheets since the pandemic lows, which should not be overlooked. Investors who have carefully selected certain airline stocks, such as United and Delta, have seen better returns compared to the broader market. Additionally, some airlines are paying dividends, indicating the potential for long-term value. While caution is warranted, the current prices of airline stocks may present opportunities for investors who can navigate the industry’s volatility.

Conclusion: US Jets Hold If You Don’t Want To Cherry Pick

Investing in the U.S. Global Jets ETF may not be the optimal choice for investors seeking exposure to the airline industry. The presence of weaker performers in the ETF’s holdings suggests that hand-picking specific airline stocks and diversifying investments within the industry may yield better results. Rising labor costs and stagnant yields pose challenges to the current cost structure of airlines. The potential for increased oil prices further affects disposable income and airline ticket spending, adding to the industry’s uncertainty. While there are opportunities for high returns, investing in airline stocks remains a high-risk endeavor that requires a pragmatic approach and a keen eye for cost rationalization.

Disclaimer: This article discusses securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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