JRNY - Will Rising Travel Demand Lift The Airline Sector?

2023-08-09 22:54:00 ET

Summary

• Travel demand has hit pre-pandemic levels.
• International demand is outpacing domestic.
• Airlines are facing rising costs for things such as labour.

Travel levels have returned to pre-pandemic levels, but is that strength being seen in the airline sector? MoneyTalk’s Greg Bonnell discusses with David Mau, Portfolio Manager with TD Asset Management.

Greg Bonnell: A busy summer travel season has seen demand for flights return to pre-pandemic levels. But is that strength being reflected in the airline stocks? Here to discuss his view on the sector, David Mau, portfolio manager with TD Asset Management. David, great to have you back on the show.

David Mau: Hi, Greg. Glad to be here.

Greg Bonnell: This is interesting. You don't have to go far. If you're on the net or picking up a newspaper about travel demand being robust, people want to get out there. They want to travel. So we're at these levels now that we haven't seen since before the pandemic in terms of that demand. What's happening with the stocks, though?

David Mau: Yeah, so, look, you're absolutely right to point out that travel demand has returned to kind of 2019 pre-pandemic levels. And what's interesting is that revenue growth, or the level of revenues projected for 2023, is actually going to be above 2019 levels. But as you said, the actual stocks of -- the share prices of these airlines are well below where they were in 2019. In fact, I would say airline share prices are probably 30% to 50% -- broadly speaking, 30% to 50% lower than they were in 2019.

There's a couple of reasons for this, but the biggest reason is expenses have gone up very significantly. So what that means is profitability of these airlines have gone down. So even though revenues are higher, profits are lower.

We know that fuel costs have gone up. Sorry. The cost of labor has gone up. And just in this inflationary environment, general operating expenses are much higher than they were four years ago in 2019. And that's being reflected in the stocks.

The other thing I think the market is taking into account is this pending recession that's been on the horizon for the last two years and hasn't really shown up yet is also weighing -- is an overhang on the share prices. So that's weighing down on the stocks as well.

Greg Bonnell: I imagine that recessionary concern, as you point out. We've been talking about it for a long time. We're still waiting for it to arrive and maybe some hopes that it doesn't arrive or we land softly. But if it did hit, it seems it would be just as the airlines are finding a recovery. There'll be another reason for people not to travel.

David Mau: There'll be another reason for people not to travel. And as far as the share prices go, you got to remember, 2020, 2021, and even part of 2022 was a very, very difficult time for the airlines. They lost -- they lost billions and billions of dollars. They haven't recovered those losses yet. So that's another thing that's being reflected in the share price right now.

Greg Bonnell: In terms of where people are traveling, I understand-- it's interesting-- there's a difference between domestic travel demand and international travel demand. The two aren't keeping pace with each other. Which one's winning out?

David Mau: Well, right now international is much-- the outlook for international travel is much, much stronger. If you look back to 2022, last year, which was the first full year that people were really starting to travel, most of the travel was happening within their respective countries. So domestic travel was very strong. But international travel was still being held back a lot by various COVID restrictions that were implemented across various countries. We had things like you had to wear masks at the airport and on the plane. And there were quarantine restrictions. And there were vaccination requirements.

So all of those things really held back a lot of international travel. But we saw most of those restrictions being lifted, I would say, kind of midway through last year. So what we're seeing now is that a lot of people got that trip to visit grandma across the country out of the way. And now they're really looking for that European vacation that they've been missing out on or that trip to Asia that they've been -- that they haven't had a chance to go on.

And so what's being reflected in the travel numbers is domestic demand is really starting to fall off. In fact, when we look at the Q2 results for most of the major US airlines, the domestic carriers, guys like Southwest, or JetBlue, or Alaska Airlines, they had a good quarter. They had a very nice Q2 ahead of expectations generally. But the outlook that they gave for third quarter and beyond is a lot softer than what people were expecting and so soft, in fact, that most of the domestic carriers will have to start cutting ticket prices starting in the third quarter after the summer travel season ends.

And that's very different from what the international carriers are seeing. So guys like United ( UAL ), Delta ( DAL ), American Airlines ( AAL ), they also had a great Q2. But their outlook for Q3 is very, very strong. They're seeing very good bookings for the third quarter and throughout the remainder of the year on their international routes. So they actually upgraded their guidance for the remainder of the year, while the domestic carriers actually lowered their guidance for the rest of 2023.

Greg Bonnell: Understandable that people who had to vacation within their own borders for a certain amount of time want to get overseas. What about business travel? I think the last time around, we were talking about the fact that that could be pretty lucrative for the airlines in terms of the cost that they charge business travelers. Is that sort of coming back in any real substantial way?

David Mau: It has come back. But when we compare to kind of 2019 levels, it's still -- we call it 15% to 25% below 2019 levels. We mentioned the recession already. I think companies are -- they're trying to be cautious. They're not trying to blow the travel budget for the year. They're trying to hold back where they can. So even though there has been a pretty meaningful recovery in business travel, it's not back to where it was a few years ago.

Greg Bonnell: You talked about rising costs for the airlines. One of their biggest costs, at least what I always understood, was the cost of fuel, right? We do have lower fuel prices than we did last time this year. Is that not enough to offset those other pressures?

David Mau: No, so fuel prices this year are definitely a tailwind. If you look back to 2022 when the price of oil hit I think about $120 versus what the price of oil is today at about $80, that's a pretty good tailwind. The price is a lot lower. But when you compare it to 2019, the price of oil was about $60. So at $80 today, your cost of fuel is still 33% higher, let's call it. So it's been -- the fuel over the last 12 months has been a good tailwind.

But other expenses are still going up. And the biggest one is labor, the cost of labor. In fact, when you look at what an airline's operating costs are, fuel is we can call it 25% to 30%. And labor is another 30, if not more, percent. So when you have both of these things higher than they were just a few years ago, it has a pretty meaningful impact on profitability.

Greg Bonnell: So those are the issues in the here and now and in the short term. What about a medium to longer term? How are the airlines set up?

David Mau: I mean, I think they have a pretty good setup. What they have to do is get these costs under control. As I just mentioned, the cost of labor is very significant, and it's been on an increasing trend. And it doesn't seem like there's an end to it yet.

Just a couple of weeks ago, we had -- I believe it was United Airlines had come to an agreement with their pilots -- their pilot union, to raise wages by 40% over the next four years. American Airlines shortly after came out with the same agreement. And this is because if they don't do this, the pilots are going to go on strike, and they're going to shut the whole thing down.

So these costs are not going away. It's just a question of how much the airlines can offset it with higher ticket prices and how powerful the unions are going to be. There's a pilot union, but there's also a cabin -- union for cabin crew, and mechanics, and air traffic controllers. And so all of these costs, when you put them all together, are going to have a significant impact.

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