Despite crude oil falling to under $29 per barrel (down from $110 per barrel just 18 months ago), many stocks in the aviation industry underperformed in 2015 and have continued their downward trajectory in 2016.
However, this isn’t the case worldwide as airline stocks in India have performed very nicely over the last few months. Airlines investors have been wondering why the fall of crude oil hasn’t propelled aviation stocks higher in the U.S., and the answer to that is very simple. Investors in the U.S. have an irrational fear of price wars.
As crude oil has fallen more than 70% since mid-2014, many airlines have reduced their ticket fares in order to attract more customers. The price wars have not gone down well with investors as the aviation stocks have sold off despite the plunge in crude.
Investors in the U.S. have an irrational fear of price wars. Back in the 1990s, when crude oil plunged to multiyear lows, many airlines slashed fares and oversupplied the market that led to the bankruptcy of many carriers. Ever since then, investors have been skeptical about airlines stocks.
Although airlines have learned from their mistakes and have been very conservative with their supply growth, investors haven’t taken a liking to the recent decline in ticket prices. Air fares have been declining gradually over the last few months, and investors are worried about yet another price war. However, it looks like airlines have learned from their mistakes as crude oil prices have plunged faster than air fares. Despite the cheaper tickets, airlines are witnessing record profits.
In fact, airline profits are expected to grow 10% this year to more than $36 billion. To put it into perspective, airline earnings stood at $17 billion in 2014. However, despite the strong earnings growth, airline stocks have sold off in the last few months and have underperformed since the start of 2015. And the only reason for this underperformance has been the market’s irrational fears.
Conclusion
While the market has irrational fears of a price war leading to bankruptcies, it’s only a matter of time before investors realize that airlines are not repeating their past mistakes. The strong earnings growth and the dim outlook for crude prices will be too hard for investors to ignore and the reality will soon catch up. Although airline stocks have sold off recently, investors should use it to buy airlines stocks like JetBlue (JBLU, Financial) and Spirit Airlines (SAVE, Financial) as it is only a matter of time before the prospects of a cheaper crude push these stocks to much higher levels.
