Airlines stocks have a pretty sloppy record as good investments. They have rarely made few people rich – those who have mustered the courage to invest in them. That says a lot about the tough nature of the airline business.
Airlines generally operate as oligopolies, meaning only a limited number of companies control the entire market. Here in Australia, we have Qantas Airways Limited (ASX: QAN), and Virgin Australia Holdings Ltd (ASX: VAH) dominating the domestic sector, together with their respective subsidiaries Jetstar and TigerAir.
Each airline, no matter how it is branded sells the same product, which is a seat on the aircraft. That is why airlines are compared with the commodity sector. Similar to the commodity sector, airlines have to accept the price as determined by the market forces. They have very limited ability to set their own prices, (any move is immediately followed by competitors) and are therefore they are price-takers.
However, intelligent speculation could work in picking the highs and lows of the airline stock, if based on the cost of inputs involved and economic conditions. Fuel is one of the biggest costs for any airlines, so a major drop in the price of oil will help increase profits. Similarly in Australia's case, a depreciating currency will bring in more overseas travellers, thus catapulting airline profits.
Virgin Australia, today reported a profit, here are the key points to take from the trading update for the first quarter ending 30 September 2015:-
- Generated an underlying profit of $8.5 million for the first quarter.
- Virgin's fully owned budget carrier Tigerair Australia delivered its first profit.
- Total revenue load factor or the percentage of seats filled across the Virgin group dropped by 1.3%.
- Positive yield growth, meaning profitability has risen even though fewer seats were filled.
- Based on current market conditions, Virgin expects to deliver a profit for the financial year 2016.
The recent meteoric rise in the share price of Qantas and today's first-quarter profit from Virgin is largely due to the macroeconomic conditions favouring the airline industry.
Virgin's return to profitability even with Tigerair's better performance could not have been possible without favourable macroeconomic conditions. A truce over the recent capacity war between Qantas and Virgin has also helped.
Foolish takeaway
Airlines are risky and speculative businesses. This is largely because their business models are heavily dependent on factors outside of management's control. A sharp rise in the price of oil or a volcanic eruption can adversely affect them. Foolish investors might be better off putting their money in other quality businesses – which should result in better outcomes.
