Traders are having second thoughts about U.S. airlines, less than five months after billionaire investor Warren Buffett disclosed major stakes in the biggest carriers.
Airline stocks are headed for the worst month since June, as United Continental Holdings Inc. said March 15 that it would add more flights and seats than originally planned. The surprise move fueled concern that a seat glut would prevent carriers from reversing a two-year slump in fares.
The question dogging the airlines is whether they can break the habit of adding so much capacity that they’re forced to offer discounts to keep planes full -- essentially, shooting themselves in the foot. United’s planned domestic capacity increase of as much as 4.5 per cent this year shook the belief that carriers would take advantage of industry consolidation to generate steadier profits amid moderate growth.
“If an airline decides to grow at any point in time greater than 3 per cent, they better have a pretty darn good explanation for that,” said Andrew Meister, analyst at Thrivent Financial for Lutherans, which holds airlines among its $116 billion in assets. “Now everyone is going to watch United like a hawk to make sure this works.”
Including United’s capacity increase, from an initial plan of no more than 2.5 per cent, domestic expansion across all carriers will be 4 per cent to 5 per cent this year, according to Morgan Stanley analyst Rajeev Lalwani. That could be more than twice this year’s expected 2.2-per-cent growth in the economy, a proxy for travel demand. Lalwani cut his rating on the U.S. industry to in-line from attractive.
“We believe industry discipline is no longer intact,” he said in a March 27 note.
United is running its business for the benefit of employees, customers and shareholders, spokeswoman Megan McCarthy said in response to questions about its capacity additions. The company also said it would boost international flights and seats as much as 2 per cent, up from a maximum of 1.5 per cent.
American Airlines Group Inc. and Delta Air Lines Inc., which are also partly owned by Buffett’s Berkshire Hathaway Inc., have maintained their goals of expanding total capacity by 1 percent. The two airlines declined to provide additional comment. Mr. Buffett didn’t respond to a message left with an assistant.
Fear that rivals would add matching flights and trigger a price war were partially assuaged after analyst reports saying that United’s increases mainly would feed more people into its hub at Chicago’s O’Hare International Airport at fares higher than Wall Street initially expected.
“If you can look past the initial gut reaction and see, ultimately, as long as that competitive response is not material or doesn’t show up at all, this is really good for United,” said Kris Kelley, an analyst at Janus Capital Management, which holds shares in United, American and Delta.
The Bloomberg U.S. Airlines Index declined 6.1 per cent since Feb. 28 through Thursday, on track for its sharpest monthly decline since June. The gauge has climbed 6.7 per cent in the past 12 months, less than half the gain of the S&P 500 Index.
Berkshire’s decision to drop its decades-old aversion to airlines was based in part on statements by American Chief Executive Officer Doug Parker that consolidation has improved the industry’s prospects from the era of bankruptcies and boom-and-bust cycles.
Mr. Parker, whose carrier also has a hub at O’Hare, called United’s capacity increase “dramatically different” from the days when airlines would battle for market share even on unprofitable routes. Still, the carrier announced new routes at O’Hare this month after United bolstered service and said its days of being a “docile competitor” were over.
Investors will have to get second- and possibly third-quarter forecasts from the airlines for passenger revenue for each seat flown a mile before concluding that “a very fragile pricing recovery” hasn’t been disrupted, said Wolfe Research analyst Hunter Keay. The benchmark measurement, a gauge of pricing power, hasn’t fully recovered from a fare war in 2015.
Keay, who initially called United’s increase “a major disappointment,” changed his mind after taking a closer look at the flights and fares.
Not everyone is convinced. The spotlight will stay on fares as long as airlines trail broad stock indexes.
“The returns on U.S. airlines this year tells you people don’t necessarily believe that its different,” said George Ferguson, an analyst at Bloomberg Intelligence. “Now is the time to find a way to make fares rise or stay stable. It’s clear to me investors are very concerned that it hasn’t changed and that’s why they’re running for the hills.”Report Typo/Error