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How Long Can Headwinds Persist for Airlines?

Blake Haxton, CFA

In 2021, we saw US consumers return to leisure travel, with demand rebounding significantly from the historically low levels we saw early in the pandemic. However, travel activity remains significantly lower than pre-pandemic levels, and Omicron-related cancellations put yet another dent in air traffic in recent weeks. This reduced demand coupled with ongoing macro issues—inflation, labor shortages and energy prices—create a challenging environment for many airlines.

People Screened at Airports

People Screened at Airports

Source: Bureau of Transportation Statistics.

The biggest question for most airlines is when–and to what extent–we’ll see a return to business travel. For business-focused airlines (American Airlines, Delta, United), margins rely heavily on keeping planes fully booked and receiving higher ticket prices from corporate travelers who typically book flights closer to departure dates. While we believe business travel will eventually recover, we don’t foresee a return to 2019 levels in the near future. Even a 75% to 85% recovery for corporate travel would still leave many airlines in a challenging spot.

Other factors impacting the airline industry are capital expenditures, labor and energy costs–each of which has independent drivers–making a sustainable recovery more challenging. On the capex side, you have the aircraft market, which has recovered quite nicely. Borrowing rates in the US have remained low, so the cost of financing planes is rather reasonable. Looking out five to 10 years, we think we’ll see more cost inflation, especially as you look at the overall supply chain for new aircraft.

Labor issues are another ongoing–and underappreciated–issue for airlines, particularly for pilots. If airlines continue to expand routes over the next few years, the US may face a pilot shortage given the current pilot population. Currently, most pilots are ages 50 to 65, with a mandatory retirement age of 65, and the pilot pipeline has been declining over the last decade. Fixing this shortage won’t be an easy task, as pilot training is difficult, expensive and time consuming, so this is shortage could be an ongoing issue for the foreseeable future.

As always, energy prices are a common input across the airline industry–all airlines must buy fuel and effectively have to pay the same price, so there's no real price advantage for any carrier. When oil prices are low, the industry as a whole tends to grow and become more profitable, at least temporarily. Then there are environments like we’re seeing today. Energy prices are high and consumer demand is tempered, so it’s challenging for airlines to pass on increased energy costs to consumers without seeing a further drop off in ticket demand, a scenario that could become a real concern for airlines if current energy prices persist or inflation drives them higher.

As long-term investors, we understand that while the current environment is challenging for many airlines, dynamics can change quickly. We have confidence in our current airline holdings—Alaska Air and Allegiant—given their higher exposure to leisure travel and superior cost management abilities, and believe they are well positioned to navigate a variety of industry headwinds.

As of December 31, 2021, Diamond Hill owned shares of Alaska Air and Allegiant Travel Co.

As of October 31, 2021, Diamond Hill owned debt of American Airlines and United Airlines.

The views expressed are those of the author as of January 2022 and are subject to change without notice. These opinions are not intended to be a forecast of future events, a guarantee of future results, or investment advice. Investing involves risk, including the possible loss of principal. Past performance is not a guarantee of future results.

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