Airline Stocks: Should You Sell the Rally?

October has been a great month for airline stocks as almost all the carriers have posted record profits thanks to low fuel prices. American Airlines (AAL) and Southwest Airlines (LUV) were no exceptions to this trend as both the carriers recently reported stunning numbers.

American Airlines reported record quarterly net profit of $1.9 billion, marking a 54% increase versus the third quarter of 2014. Total revenue in the third quarter was $10.7 billion. While the revenues were in-line with the analysts’ estimates, earnings surpassed the targets.
Given that American Airlines doesn’t hedge fuel, the substantial increase in earnings isn’t surprising. America Airlines is benefiting the most from its “no hedge” policy which is why I think the company’s earnings will continue expanding.

On the other hand, Southwest Airlines reported Q3 EPS of $0.94, beating the analysts’ estimate by $0.02. Revenue of $5.32 billion was also ahead of the consensus target of $5.1 billion. Both the stocks have gained strongly after the earnings report. I have recommended buying both American Airlines and Southwest Airlines to investors at lower levels in the past, and both stocks have yielded double-digit returns.

While I still think both the companies have several tailwinds, I think airline investors should be cautious and consider booking profits amid the recent rally. The sentiment surrounding the aviation industry is negative, and a weak air fare environment can wipe the gains of cheaper crude.

A few months ago, American’s CEO had stated that the company would compete against low-cost rivals like Spirit (SAVE) on price and the news didn’t go down well with the investors. Since then, average air fares have fallen consistently for the month of July, August, and September. While the companies have still enjoyed record profits as crude oil prices have fallen faster than air fares, they may face problems once crude prices start rising again.

Of the two stocks mentioned above, I think American Airlines is at a bigger risk as investors have turned cautious. American’s decision to not pay back debt and continue spending on share repurchases hasn’t gone down well with investors. With a debt to equity ratio of 5:1, American is highly prone to an economic slowdown.

On the contrary, I think Southwest is a less risky investment as the company recently expanded to international markets. Generally, international flights are fuller than local flights, so I expect Southwest’s revenue and earnings growth to continue.


I do think I am being overly paranoid about the outlook of the aviation industry, but since I have recommended both these stocks earlier at cheaper levels, I think investors can consider booking partial or complete profits. In my opinion, investors should sell American Airlines at present and buy on any overblown weakness in the future. As for Southwest, I think investors should hold the stock for another quarter.
Published on Oct 27, 2015
By Ayush Singh

Copyrighted 2016. Content published with author's permission.

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