Airline stocks are a classic hedge against lower oil prices explains Elliott Gue. The editor of Energy & Income Advisor turns to the airline sector for his favorite speculative idea for the coming year.
Over the 12 months ended September 30, 2014, American Airlines (AAL) spent almost $12.5 billion on jet fuel, a sizable chunk of the carrier's $40 billion in revenue and about 35% of its total operating expenses.
Yet, despite the elevated oil prices of recent years, the major US carriers have enjoyed a resurgence in profitability, fueled by industry consolidation and a commitment to reducing capacity by grounding older planes and eliminating unprofitable routes. These efforts have resulted in fuller planes and more revenue per seat.
Some observers had worried that plummeting oil prices would prompt carriers to increase capacity in an effort to take advantage of strengthening US travel demand.
In its third quarter conference call, American Airlines assuaged some of these concerns, underscoring that the company prefers to let this tailwind lift profits instead of investing this influx of cash.
Management realizes that oil prices can turn in a hurry; making long-term decisions on capacity based on short-term swings in jet-fuel prices isn't good business.
Although all airlines will benefit from falling jet fuel costs to some extent, hedges taken out to protect carriers from rising oil prices will limit these savings in the near term.
But, American Airlines doesn't hedge its fuel expenses at all, providing superior leverage to further downside in jet-fuel prices (the primary reason the stock outperformed the NYSE ARCA Exchange Airline Index by an almost 3-to-1 margin in 2014). American Airlines rates a buy under $55.
