June 8, 2015 / 7:50 PM / 2 years ago

Airlines hit headwinds from investors as they try to capture growth

(Reuters) - Major U.S. airlines’ shares tumbled on Monday amid fears that the carriers are grabbing for market share at the expense of profits.

Flight personnel stand inside the airport in Puebla May 10, 2012. REUTERS/Imelda Medina

Shares in Delta Air Lines Inc (DAL.N) , Southwest Airlines Co (LUV.N), United Continental Holdings Inc (UAL.N) and American Airlines Group Inc (AAL.O) all fell sharply despite a bullish outlook on industry profitability issued Monday by the International Air Transport Association (IATA) at its general meeting in Miami.

Global airlines should earn $29.3 billion this year, nearly double last year’s level, and average net profit margins should nearly double to 4 percent from 2.2 percent, the industry group forecast. [ID: nL5N0YU265]

Wall Street, however, focused on concerns that big U.S. airlines are casting aside years of disciplined efforts to limit capacity and boost profit margins for each mile a passenger flies.

In a series of moves over the past few weeks, Delta, Southwest, American and other carriers have announced plans to add more planes or put more seats on existing aircraft on certain routes.

Raymond James on Monday cut its ratings for Delta and United Continental to “outperform” from “strong buy,” and for American to “market perform” from “outperform.”

Raymond James analyst Savanthi Syth said in a research note that while he expected the industry to maintain capacity discipline, the industry’s recovery “is likely to be somewhat muted vs. previous expectations due to the softer than expected U.S. economic growth.”

Delta shares were down 4.6 percent, while American fell 4.2 percent, with Southwest losing 2.5 percent and United slumping 4.9 percent.

MORE SEATS

Industry executives gathered at the IATA conference said it made sense to set a course for increased overall revenues and profits at a time when fuel costs are low and air travel is expected to grow. In a growing market, sticking to a focus on revenue per passenger-mile by limiting the number of planes or seats could result in a company missing out on revenue.

“I don’t know that anywhere you will find a major airline in the face of almost a 50 percent drop in fuel prices reducing its capacity at the same time,” Delta President Ed Bastian said at a news conference at IATA. “We are continuing sustainable momentum and continuing with the discipline that the marketplace is expecting.”

Delta last week warned investors profit margins could be lower than it previously expected.

United’s Chief Financial Officer John Rainey said during an investor conference Thursday that increasing capacity by squeezing more seats onto aircraft – instead of buying new planes – could dilute unit revenue but is “earnings accretive” overall.

IATA’s official forecast was bullish on capacity.

“A focus on efficiency is seeing supply matched more closely than ever with demand and is expected to produce a record high load factor of 80.2 percent,” IATA said in a statement, referring to the proportion of seats sold on an average flight. However, the group’s chief economist, Brian Pearce, took a more cautious line, noting margins remain narrow.

‘FEELS DIFFERENT’

“To the extent that capacity does come into the market ahead of the demand from consumers that’s going to make it difficult for the airlines to sustain profitability,” Pearce said.

U.S. airlines will account for more than half of the industry’s total profits this year, IATA said.

Total industry revenues are expected to dip to $727 billion from last year’s $733 billion, but lower fuel costs and record load factors are boosting profits, IATA said.

Monday’s selloff reflected the fear that airlines will repeat their history of overshooting the market, adding too many seats and then selling them off at firesale prices.

”The real question is, is this a one-time catch up for fuel prices being lower or is this airlines behaving like airlines used to and just increasing capacity because times are good,” American Airlines Chief Executive Doug Parker said Sunday, responding to the concerns of investors.

This cycle “feels different,” Parker said, because industry executives remember what happened in the past, before the Great Recession drove airlines to tighten capacity and cut costs.

Air Canada (AC.TO) Chief Executive Calin Rovinescu said he too sees little risk of a damaging capacity war.

“People were undisciplined in the past, but they will be more disciplined this time,” Rovinescu told Reuters on Sunday. “However, we will see rational growth where it makes sense to do it.”

Gary Bradshaw, portfolio manager at Hodges Capital, said Monday he is using the weakness in airline shares as a buying opportunity.

“We still think earnings will be great this year for the airlines,” Bradshaw said.

JPMorgan analyst Jamie Baker also took a positive view during a presentation to investors last month, arguing that airlines risk leaving money on the table if they do not keep pace with rising demand.

“Capacity has been growing for several years, and guess what: profits have been growing faster,” Baker said.

Additional reporting by Alwyn Scott and Sinead Carew. Editing by Joseph White and Christian Plumb

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