Shares of the country’s biggest aviation stocks led the S&P 500 higher on Thursday following the release of a report from Wall Street titan JPMorgan Chase & Co. (JPM). Investors reacted very positively to the news, sending the industry’s most dominant firms like American Airlines Group Inc. (AAL) and United Continental Holdings Inc. (UAL) toward their highest levels in over a month.
The rally comes at an interesting time for airlines, which constitute a macro-economically sensitive industry that has been racked recently by heightened trade tensions and the widespread grounding of Boeing Co.’s (BA) 737 MAX jets. This leaves investors wondering if Thursday’s gains are the start of a long-term rebound or simply a fluke.
Here’s a closer look at the news that boosted airline stocks on Thursday – and what it means for the industry going forward…
In a note to investors, JPMorgan analyst Jamie Baker said American Airlines hiked the price of its domestic fares by $5 one-way on Wednesday for the second time in five weeks. Other airliners – including Hawaiian Holdings Inc. (HA) and the largest U.S. carrier Southwest Airlines Co. (LUV) – quickly followed suit, with Hawaiian Holdings matching the $5 hike and Southwest implementing a “substantive” boost.
Baker elaborated on the industry-wide move by noting how airlines are benefiting from their aggressive streak of price hikes, which includes one back in the second week of May. He said that the grounding of the 737 jets made him obsess “over domestic fares much less than usual, given what we viewed as a low probability of further increases.” However, he concluded that “we are pleased that our skepticism was proven ill-placed.”
How Investors Reacted
Airline stocks rallied across the board, with American Airlines, United Continental, and Southwest Airlines rounding out the S&P 500’s top 10 performers. Shares of those three firms climbed 6.4%, 4%, and 3.1%, respectively. AAL closed at $33.09 for the best settlement since May 10, while UAL ended the day at $87.11 per share for the highest close since May 6.
The Bigger Picture
Understanding the airline industry requires understanding the reactionary environment that its biggest companies operate in. While airlines aren’t allowed to collude on fare models, they do monitor each other’s prices closely so they can try to match each other’s rates and stay competitive. For this reason, an attempt by one airline to raise fares often either succeeds or fails based on whether competitors choose to match the price – a scenario that investors saw unfold on Thursday.
It may seem bad for business when companies race each other’s airfares higher instead of keeping their prices low to draw customers. After all, Southwest has a long and celebrated track record of resisting airfare hikes amid the rest of the industry. But the reality is that the reactionary strategy outlined above actually tends to work, and Southwest has demonstrated this over the last five weeks. It was one of the first airlines to raise airfares during that first wave of hikes in early May, hiking the price of 180,000 individual flights by $5. As the largest airline in the U.S., it’s clear Southwest has become something of an industry arbiter for the success of price hikes.
What’s also interesting about the move is how airlines don’t particularly have much of a need to increase ticket prices to cover certain market-influenced expenses. For example, the average airfare price tends to rise when crude oil prices are elevated as a result of airlines passing on those higher fuel costs to the consumer. With West Texas Intermediate (WTI) – the U.S. benchmark price for crude oil – currently at a five-month low of $52 a barrel, the airfare hikes are clearly the airlines’ way of betting on robust demand continuing throughout the summer.
Airlines have been busy trying to shake off the 737 MAX scandal that tanked the entire industry earlier this year. The success of this week’s price hike indicates customers are comfortable flying again, even willing to pay more to travel in the near term.
That being said, investors may be able to play the big airline stocks for quick profits. However, the industry is still ripe with volatility, with giants like UAL experiencing three triple-digit one-month drops since November. Investors should at least wait until the 737 MAX situation completely blows over before seriously considering these stocks as long-term plays.