Airline stocks lose altitude on concerns about capacity growth

Growth from Spirit Airlines and Southwest Airlines has put pressure on American Airlines at Dallas-Fort Worth Airport.
Growth from Spirit Airlines and Southwest Airlines has put pressure on American Airlines at Dallas-Fort Worth Airport. Star-Telegram

Airline stocks, which have been soaring thanks to lower oil prices, hit a little turbulence last week as investors began to question network growth plans at the major carriers.

Shares of the four largest U.S. carriers all lost around 10 percent of their value, with most of the stock price declines coming Wednesday, a day after several airline executives discussed capacity growth at an investor conference.

“We believe the investment community is clearly fed up with airlines growing at a reckless pace,” Cowen & Company analyst Helane Becker said in a research note after the stocks took a dive. “The airlines have clearly started their reckless ways as a result of lower jet fuel costs. We were comfortable with the initial growth, but the current trajectory is worrisome.”

On Tuesday, Southwest Airlines Chief Financial Officer Tammy Romo revealed that the Dallas-based airline would grow capacity this year between 7 to 8 percent as it adds international flights in Houston and continues to receive larger 737-800 aircraft from Boeing to replace older, smaller 737s. Initially, Southwest had only planned to grow about 6 percent with most of the new flying operated out of Dallas Love Field following the repeal of the Wright Amendment.

“For this year, we have pretty unique opportunities to grow,” Romo said at the Wolfe Research Global Transportation Conference.

But that was not what investors wanted to hear, More than 30 million shares of Southwest stock (ticker: LUV) traded Wednesday, sending the stock down over 9 percent in one day.

In a recent research note to investors, Wolfe Research analyst Hunter Keay called the current capacity growth in the industry a Mexican standoff.

“Four airlines with guns pointed at each other. Each is afraid to cut suddenly profitable routes because they fear another will backfill that route,” Keay wrote in a research note last week.

Shares of Fort Worth-based American Airlines Group (ticker: AAL) had the second sharpest decline last week, down 12 percent, behind only United Airlines. American President Scott Kirby told investors that he thought the capacity growth this year in the industry is likely to continue in 2016 and margins may fall as a result.

In Dallas-Fort Worth, where American is competing with Spirit Airlines and Southwest, capacity has grown as Spirit and Southwest have added flights. But American has said it doesn’t plan to cut capacity at its hub at DFW Airport as a response.

“We have to be competitive with those guys, because there’s a big segment of our customer base, not all of it, but a big segment of our customer base shops on price, and we need to compete for those customers as well,” Kirby said at the conference.

Part of the problem is how airline executives are communicating their growth plans to investors, analysts said.

“Nothing Southwest or American said was truly new or shocking to us,” Becker said. “Their message has been consistent, but the lack of explanation may have changed.”

Several airlines, including both American and Southwest, recently announced stock repurchase plans to help increase their share price and investor value.

CRT Capital analyst Michael Derchin views the stock buybacks as evidence that the airline industry has changed and is not as cyclical as it has been in previous decades.

“The historic ‘boom-and-bust’ cycle will likely be replaced with a much more stable, extended cyclical growth cycle, with higher earnings in expansions and lower earnings, but not red ink, in recessions, in our view,” Derchin said.

Wall Street analysts believe there may be continued short-term pressure on airline stocks as the carriers announce their May traffic results early next month.

“The real issue here is that airlines think that Wall Street still cares about financial metrics, like [return on investment capital] and cash flow,” Keay said. “The reality is: We don’t. We just want to see good behavior.”

Andrea Ahles, 817-390-7631

Twitter: @Sky_Talk


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