Higher Oil Prices: Good For Airlines?

Airline stocks like Delta (DAL), American (AAL) and United Continental (UAL) have soared this year, and the engine of their gains have been powered by a number of factors, including better cost management, less competition and even stable fuel prices.

Bloomberg News

The latter has been called into question today, as oil prices have surged thanks to turmoil in Iraq–pulling the Delta, American and United Continental down in the process. Shares of Delta Air Lines have slid 5.7% to $42.67 at 11:22 a.m. today, while United Continental has plunged 5.7% to $42.69 and American Airlines has tumbled 5.8% to $39.83.

The airline losses have pulled the Dow Transportation Average down 1.9% today, while the Dow Jones Industrial Average has fallen just 0.7%. That’s already starting to worry some because the Transports have been a market leader this year, as this chart, which shows the performance of the Transports relative to the Industrials, demonstrates (click for a larger image):

Wolfe Research’s Hunter Keay and Jared Shojaian note that higher oil prices aren’t necessarily bad news for airlines:

High oil prices are good for airlines, for those that have forgotten. Since 2008 airline stocks and oil prices have moved with each other to the tune of +0.68, a reversal from the trend in 1995-2008 where they had an inverse correlation of -0.64. Buying opportunities arise when supply driven disruptions in oil prices cause selloffs…

There is no news out there that we've seen that changes our bull case on airlines. They can't go up forever, and they remain high beta stocks. Valuations suggest investors still aren't treating airline stocks like anything other than low quality industrial names, so pullbacks like this should be expected. We view this as a buying opportunity for Delta Air Lines, who has shown the best pricing power on a consistent basis over the last year.

In a note released this morning, Morgan Stanley’s John Godyn addressed investor concerns following yesterday’s Lufthansa-inspired drop in American Airlines, United Continental and Delta Air Lines:

With some of our OWs up in the ~50-65% range YTD (Delta Air Lines and American Airlines in particular) after having been leaders in the market in 2013, a growing sense that YoY price growth is bound to slow at some point, and profit warnings from global airlines stoking fears of int'l overcapacity, investors are growing concerned. Though we can’t predict day-to-day volatility, we believe such concerns, should they persist, would form the basis of a buying opportunity for most airlines. We believe there continues to be under-appreciated pricing power left this cycle…

Airline investors better hope so.