Airline stocks have hit some recent turbulence amid concerns over slowing global economic growth and the Ebola outbreak, but some investors see a buying opportunity, especially as lower fuel prices cut operating costs.
Shares of Canada's two major airlines, WestJet Airlines Ltd. and Air Canada, have dipped in recent weeks, even as both report steady traffic increases and expect to receive extra revenue from newly introduced baggage fees.
A lower Canadian dollar is a headwind for the airlines, since they make major purchases in U.S. dollars, such as fuel, which makes up about 25 per cent to 35 per cent of an airline's cost base. Some analysts say that should be offset by the drop in the price of the commodity produced from oil.
Benchmark Gulf Coast jet fuel prices have fallen to about $2.40 (U.S.) per gallon, down almost 20 per cent from $2.95 in June.
"The dramatic drop in fuel prices recently does, in our view, provide significant cost relief that should benefit everyone in the industry," said Ben Cherniavsky, an analyst at Raymond James Ltd., in a recent note.
Still, he discourages investors from viewing airline stocks as a way to play falling oil prices, saying GDP growth has a greater impact on airline profits. "It doesn't matter what fuel costs if the seats are empty," Mr. Cherniavsky said.
He has a "strong buy" on WestJet, calling it the carrier with the lower costs, and recently upgraded Air Canada to "market perform" (similar to a hold) from "underperform" (similar to a sell), citing lower fuel prices and its underperformance compared with the overall sector and the S&P/TSX composite index.
Air Canada shares have fallen about 25 per cent from a six-year high of $10.90 (Canadian) reached in June. WestJet shares hit an all-time high of $33.33 in mid-September, but have fallen about 7 per cent since. (Both stocks have recovered in the past couple of days alongside the broader markets.)
Both stocks have been affected by concerns about the impact on traffic from a downturn in the global economy, the spread of the Ebola virus and competition from other, smaller carriers.
Konark Gupta, an analyst at Macquarie Capital Markets, said Air Canada has been harder hit than WestJet and over a longer period because of its thinner margins and greater exposure to international markets, including the weakening European economy.
Mr. Gupta also doesn't believe investors should bet on lower fuel prices to lower costs long-term.
"Fuel is uncertain. What we are seeing with fuel prices right now is likely a temporary shift. [Prices] could rebound," said Mr. Gupta, who has a "buy" on WestJet and a "hold" on Air Canada.
Bruce Campbell, president and portfolio manager at Campbell Lee & Ross, said his firm doesn't own airline stocks because the industry's costs are mainly fuel and labour, both of which they have little control over.
However, if the stocks were hit by a rebound in fuel prices he might consider them as a short-term play given what he calls the "fragile psyche of the market" today.
"We don't like the long-term business, but if they got hit a lot then you might have to look and say, 'There's so much value here we have to do it.' If we did do that it would be new for us," he said.
BMO Nesbitt Burns analyst Fadi Chamoun said steep sell-offs in airline stocks have proven to be a buying opportunities in the past, with the exception of recessions.
"We do not sense the demand environment has deteriorated and we remain positive on the outlook for passenger traffic," Mr. Chamoun said in a note. He has an "outperform" on both Air Canada and WestJet.
Canaccord Genuity analyst David Tyerman believes it's a good time to buy airline stocks, but said the "wild card" is the health of the North American economy.
"At this point, the Canadian and U.S. economic outlook remains supportive for airline demand," Mr. Tyerman said in a note.