asyJet and IAG were top performers on the FTSE
yesterday reversing the recent downward spiral that saw the former hit 6-month lows.
Until the crisis in Iraq, airlines had outperformed broader markets with the companies benefiting from a pick-up in travel demand with the global economic recovery, less competition and steady oil prices.
International flight competition had been reduced by mergers and code share partnerships between the airlines, for example American airlines merged with US Airways while also code-sharing with British Airways. As a result, airlines have been able to increase airfares with less chance of losing seats to competitors.
The average airline profit is $6 per customer with profit margins around 1-2%. Fuelling an aircraft is around a third of an airline’s total expense so the thin profit margins make them very susceptible to spikes in the price of oil.
For most of 2014, rising crude oil production in the US has helped offset supply shortages from the likes of Libya and Sudan. This changed on Monday June 9th when oil prices rose sharply with increasing sectarian violence in Iraq which had seen 100 people killed in one day over the weekend. Iraq is Opec’s second-biggest oil producer and airline stocks nosedived on average 4-5% in one day.
Brent has now reached a high of over $116 while WTI hit just above $107.50, up 10% and 17% respectively from the beginning of the year.
In a double whammy for the airline sector, on June 11th, Lufthansa gave a profit warning citing increased competition from gulf state airlines including Emirates and Qatar Airways. Airline stock prices dropped another 3-5% on the day.
If oil prices remain at elevated levels and gulf airlines continue to increase market share, it may be that the main fundamentals that had driven the outperformance of the airline sector, namely the reduced competition and stable oil prices have changed. After a period of outsized gains, the airline sector risks underperforming broader indices for the rest of the year.
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