LUV - U.S. Global Jets ETF: Pressure Mounts On SVB Financial Group Collapse News

2023-03-15 17:15:53 ET

Summary

• Spread of banking crisis could result in reduction in top-line growth for airlines and hurt the U.S. Global Jets ETF.
• In such scenario, airlines would be left with a lower top-line growth while higher labor costs are locked in via collective bargaining agreements.
• Lower interest rates could reduce cost of debt but spur inflationary cost items.
• Current projections do not yet show significant weakening, but there is reason to be cautious.

With the turmoil in the banking sector, things are getting challenging for investments in the airline industry. Obviously, the demand recovery has been robust for airlines, but we are also seeing some increased risks which I discuss in this report. As various airlines part of the U.S. Global Jets ETF ( JETS ) also updated their guidance, I will be discussing those updated outlooks for Q1 2023 and 2023 as well.

A Banking Sector Crisis Risk For Airline Stocks

There really are several pain points that could be affecting airlines. Demand projections for the year have been robust, but one can wonder what the current challenges in the banking sector will do to the demand profile that was projected by airlines. In isolated view, the collapse of the Silicon Valley Bank of SVB Financial Group (SIVB) might reduce travel demand on some specific routes, but that is not something that I believe has major impact.

The bigger impact is on consumer confidence and their willingness to spend money as they see pressure on the banking system. Right now, interest rates have increased sharply, and that has a negative effect on government bonds invested in times of low interest rate environments. Normally these bonds are low-risk, but with higher interest rates those government bonds are lower in demand and the value of the bonds tumble. With high interest rates, the cost of financing is also increasing and that makes companies including airlines more willing to pull money from bank accounts.

In short, that is what resulted in the collapse of SVB but then focused on startups pulling the money. The problem is that the pressure on the banking system has become more visible and it might spread throughout the banking system. The consumer is seeing this, and that might make them rethink their travel spending, resulting in lower demand for air travel and softening air fares. Particularly, for airlines this could be a pain point, as many airlines have agreed on wage increases for staff as inflation soared. So, they will be left with lower top-line growth and a higher cost basis. That is not how you optimize a business. Furthermore, the pressure on the banking system could further increase inflation and this affects some inflationary cost items such as airport handling fees and navigation. Lower interest rates could again make it cheaper for airlines to borrow and lease airplanes, but generally we are seeing the inflation effect translating faster to the P&L statements than changes in interest rates.

So, the risk for airlines is there and investors see it and airline investments might seem less rewarding. Furthermore, investors might also be rethinking their asset allocation and their portfolio exposures which also might not bode well for airline stocks. So, airline stocks are under pressure from multiple sides.

Guidance Change For Airlines In 2023

Yesterday, we saw some airlines changing their guidance. Delta Air Lines, Inc. ( DAL ) maintained its guidance, which is a plus.

Southwest Airlines ( LUV ) tightened the range on their operating revenue guidance and guided lower on fuel costs, but higher on CASM-X related to customer compensations and additional technology investments. For the full year, the capacity growth has been trimmed with Southwest Airlines stating they are adopting a more conservative approach. This could either be a sign of expected weaker demand in the fourth quarter or more padding into the schedules to prevent the chaos it saw last year during the winter season. I wouldn’t say it is a bad guidance, it is guidance that better incorporates required investments, costs and risk assessments.

United Airlines has guided higher on capacity and lower on TRASM for the first quarter due to changes in demand profiles compared to previous years were lower demand months are showing less growth from prior levels and higher demand months show higher growth. For the first quarter that effect is negative, but one can also wonder whether capacity growth has not started to weaken air fares. Furthermore, the company expects higher fuel costs and has incorporated the effect of the new collective bargaining agreement into the first quarter ahead of the scheduled recognition in the second quarter. Similarly, Alaska Air Group, Inc. ( ALK ) also sees higher costs due in part to new agreements with staff; it expects lower margins due to higher than anticipated fuel prices.

The airline that is probably most upbeat on the first quarter is JetBlue Airways Corporation ( JBLU ), the airline is expecting that capacity growth might exceed prior expectations while its revenue growth is expected to be even stronger than expected and continue to outpace capacity growth. Due to the capacity expansion, CASM-X is expected to grow less than previously expected, but there is a negative offset on fuel prices resulting in loss per share forecast to be maintained for the first quarter.

Overall, we are not seeing major weakening in demand, but we do see that there is reason to be cautious and the recent projections do not yet include any outfall of travel spending that may arise from reduced confidence in the banking system.

What Holdings Are In The Jets ETF?

The top airline holdings in the U.S. Global Jets ETF are:

1. United Airlines ( UAL ) with 12.03%.
2. American Airlines ( AAL ) with 11.68%
3. Delta Air Lines ((DAL)) with 11.23%
4. Southwest Airlines ((LUV)) with 8.95%
5. Allegiant Travel ( ALGT ) with 3.69%
6. Air Canada ( ACDVF ) with 2.94%
7. Alaska Airlines ((ALK)) with 2.91%
8. JetBlue ((JBLU)) with 2.75%.

So, with some softening for the top holdings combined with the market caution, it is not odd that we see that the US Jets ETF has lost over 8% this week.

Conclusion: U.S. Jets ETF Is Hardly Attractive In A Higher-Risk Environment

My view on the U.S. Global Jets ETF has always been that you might be better off by just handpicking your airline of preference. You could go for investment in the basket of airline names if you want to spread your investments over multiple names in the industry, but even then you might want to select those by hand. I currently don’t view investment in the U.S. Global Jets ETF as wise due to the risks faced and the risks that might grow this year and are not yet translated into the guidance.

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