Transportation

Could Rising Fuel Prices Crush Airline Stock Rally?

Douglas A. McIntyre

Published: February 18, 2017 8:40 am

Last Updated: January 12, 2020 2:42 pm

Warren Buffett of Berkshire Hathaway Inc. (NYSE: BRK-A) likes airlines. His opinion has sent shares of companies in the industry higher. One thing on the horizon that could affect the optimism about the industry is that fuel prices have started to rise and already have wounded the earnings of one carrier.

Buffett added to his positions in American Airlines Group Inc. (NASDAQ: AAL) and United Continental Holding Inc. (NYSE: UAL) last quarter and took an initial stake in Southwest Airlines Co. (NYSE: LUV), according to a 24/7 Wall St. analysis. After the announcement, American shares moved near a 52-week high, trading at $47, just shy of the period’s peak of $51. United jumped to $76, just short of its 52-week high of $77. Southwest’s shares reached $58, a period high.

Recently Air Canada dropped a piece of bad news. Fuel costs hit its bottom line. According to Bloomberg on February 17:

Air Canada dropped the most in seven months after the country’s largest airline said rising fuel costs would cause a key profit measure to fall by half in the first quarter.

The forecast implies earnings before interest, taxes, depreciation and aircraft rent of C$250 million ($190 million) in the first quarter, trailing the C$366 million estimated by Fadi Chamoun, an analyst at BMO Capital Markets. A margin of 6.9 percent, half of last year’s level, would fall well short of the 12 percent predicted by Cowen & Co., which also expected lower non-fuel costs.

Buffett’s positions are likely due to his view of the long-term health of the industry, which is usually the approach he takes. However, that does not mean the next few quarters will be prosperous for the airlines.

Aviation Daily recently pointed out that:

Delta Air Lines has decided to keep capacity flat for the first quarter as it anticipates fuel prices during the period to be $1.68-1.73 per gallon, which is 30% higher than in 2016, when oil prices were closer to $35 per barrel,

At $53 a barrel, crude oil prices are just shy of their 52-week high of $56, but well above the period low of $39. Traders are split on what will happen to the price as 2017 progresses. One thing is almost certain: the price will not drop below $40 anytime soon. Airlines and their shareholders are stuck with an expense that cannot be done away with by cost cutting. The 52-weeks highs among industry shares are at risk of a downturn.