Just when you thought that airline stocks had begun to shake off a well-deserved reputation for dismal performance, along comes the sobering reality: WestJet Airlines Ltd. has fallen 9 per cent this year and Air Canada has slumped nearly 40 per cent since mid-January, ending last year's dazzling rally.
Transat A.T. Inc. is the latest casualty. After the tour operator reported a bigger-than-expected first quarter loss on Thursday, the shares slid 20 per cent.
That marks the stock's biggest one-day decline in three years and serves as a head-slapping reminder that airline stocks are notoriously dangerous for long-term investors.
This year's declines follow big upward moves in 2013, when an improving economy, the rollout of more efficient airplanes and falling operating costs drove investor interest in the sector. WestJet shares rose 41 per cent, Transat rose 113 per cent and Air Canada surged 320 per cent.
U.S. airline stocks also had a good year, after a flurry of mergers reduced the number of key players in the industry and raised the pleasant prospect (for shareholders, at least) of an oligopoly that could charge for in-flight meals, checked bags and just about anything else.
What has changed? Canadian airlines have been pointing to the weak Canadian dollar, which has fallen to about 90 cents against the U.S. dollar this year, its lowest level since 2009.
Since jet fuel – which accounts for about 30 per cent of airline expenses – and jets themselves are priced in U.S. dollars, the weaker loonie is raising some of the key operating costs of airlines.
Transat's chief executive, Jean-Marc Eustache, blamed the dollar when he announced the company's loss of $25.6-million (Canadian) or 60 cents a share after adjusting for some extraordinary items. Analysts had been expecting an adjusted loss of just 45 cents a share.
Air Canada doesn't announce its first-quarter results until May 2, but chief executive Calin Rovinescu is already laying the groundwork, telling Bloomberg News last week that it is considering new fees and fare increases to offset the effects of the weaker dollar.
WestJet, the most consistently profitable of the three airlines, will report its results on May 6. Analysts expect adjusted profit to fall to about 65 cents a share, down from 68 cents last year.
RBC Dominion Securities recently reduced its recommendation on the stock from "outperform" to "sector perform," and slashed its target price from $34 to $28, arguing that the company is having a tough time offsetting rising costs.
The Canadian dollar could rebound, of course, which would provide a nice earnings boost, or at least unwind some of the recent damage.
But either way, the current round of anxiety over airline profitability underscores how sensitive the sector is to factors largely beyond its control. That's because airlines operate with notoriously thin profit margins, even when things are going well.
The International Air Transport Association reported on Wednesday that global airlines are expected to generate a net profit margin of just 2.5 per cent this year – "a fragile margin in a risky business environment," the IATA said.
Put another way, airlines will make just $5.65 (U.S.) per passenger in 2014, which isn't comforting when this year's rise in oil prices is already expected to add $3-billion to the global industry's fuel bill.
No wonder airline stocks are no place for long-term investors: While short-term gains can be magnificent, the downside risks are huge – and far more likely.