Oil Prices and Airline Stocks

 

Why are Southwest and JetBlue outperforming the larger airline companies even though they are all affected by the fall in oil prices? From an economics perspective, if all other factors are held constant, a decrease in an input cost leads to greater profit margins for the firm. It could be assumed that improved margins for a firm would lead to higher stock prices and better performance, but this is not the case with airline stocks and the recent fall in oil prices. Deutsche Bank estimates that for “$1 per barrel change in jet fuel prices moves pre-tax industry profits by $400 million” (Deutsche Bank – Forbes.com) If the increase in industry profits is so large, why are the largest airline companies performing so poorly? Economists point to the demand side of the market and the ability of airlines to offset changes in fuel costs.

(http://vishwagujarat.centricwebsoluti.netdna-cdn.com/wp-content/uploads/2015/01/Oil_Firms_Hike_7124.jpg)

Demand for crude oil has decreased due to static economies, especially in China. Combining this decrease in demand with an increase in domestic oil production causes a fall in the price. The lack of economic growth in China has caused the nation to demand less crude oil for infrastructure and building purposes. All of these factors combined leads to cheaper prices at the pump and cheaper barrels of crude oil for manufacturing jet fuel.

In the United States, the most prominent airlines are Delta, United, and American. These airlines have seen the most dramatic fall in returns over the last year, which has caused investors to avoid the big three airlines and explore other options such as Southwest and JetBlue. In the image below, from Forbes.com, you can see that the smaller airlines, especially JetBlue and Southwest, have seen significant increases in stock price relative to Delta, United, and American.

chart1

(AAL Data by YCharts)

Poor performance for airline stocks is obviously not an intuitive result for a decrease in oil prices, so there must be multiple other factors at play. Why are JetBlue and Southwest blowing the big three airlines out of the water? All airlines rely on oil as a production cost, so the increase in performance for JetBlue and Southwest must be derived from a different sector of the airline business.

Southwest Airlines has provided consumers with low fares and open seating on domestic flights for decades, and their stock prices are reflecting the preferences of American travelers. Also, business travelers favor Southwest because the airline is regularly on time due to fast boarding and baggage services. These logistical and economic factors are probably the most pertinent reasons, but Southwest customers also value the friendly and dedicated flight attendants and customer service agents. Air travel is pricey and often stressful, so it makes sense that consumers strongly favor airlines with helpful and kind employees. Personally, I regularly feel that the customer service agents for airlines such as United or American are out to squeeze my wallet, piss me off, and make me never want to fly with them again. These company characteristics have been a staple of Southwest’s business and success for decades, and the relationship that Southwest has with JetBlue can explain some of their successes as well.

southwest

(http://airportjournals.com/wp-content/uploads/0803019_9.jpg)

JetBlue’s founder, David Neeleman, surrounded himself with ex-Southwest executives and set out to create an alternative low cost airline to Southwest. Features such as in-flight entertainment set JetBlue apart from other discount airlines, and this could explain some of the business success. (References For Business) Despite in-flight entertainment systems, JetBlue keeps their costs down by cutting out unnecessary features that do not improve the customer’s experience. Neeleman describes his business strategy in the following quote, “You can be efficient and effective and deliver a great experience at the same time” (David Neeleman, icmrindia.org) One example of JetBlue decreasing costs is that they do not serve meals on their flights. This is a smart cost to cut because very few people enjoy, or want, the airline provided meals anyways. By getting rid of the food plan, JetBlue does not have to purchase any food, deal with food companies, or throw away uneaten meals at the end of a trip. These airline characteristics have helped JetBlue stocks grow from below $5/share to about $20/share since 2012. (Data provided by Yahoo finance) However, investors need to be cautious with JetBlue because the company cannot grow forever. One of the main reasons that JetBlue has been so successful is the culture of the growing company and the type of employees hired. As the company grows it will be increasingly difficult to maintain the culture and quality of employees.

 chart2

(google.com)

We have seen that a fall in oil prices leads to more favorable profit margins for firms, but in this example it does not directly relate to the performance of stocks. Economists explain that the oil market is very unpredictable, and that the changes in prices are usually offset by airlines. Input costs for different airlines are very similar, so it might be surprising that JetBlue and Southwest are outperforming the larger airlines. With this said, Southwest and JetBlue have been able to increase their performance by cutting costs, providing more enjoyable services, and dominating the business travel market.

Works Cited:

“3 Airline Stocks Affected In Light On Dropping Oil Prices – (AAL), Delta Air Lines Inc. (New) (NYSE:DAL).” Benzinga. 12 Dec. 2014. Web. 21 Apr. 2015.

Beattie, Andrew. “Weak Oil Prices and Airline Profits.” Investopedia. 18 Dec. 2014. Web. 21 Apr. 2015.

Gallo, Carmine. “Southwest Airlines Motivates Its Employees With A Purpose Bigger Than A Paycheck.” Forbes. Forbes Magazine, 21 Jan. 2014. Web. 21 Apr. 2015.

“JetBlue | About | History.” JetBlue | About | History. 2015. Web. 21 Apr. 2015.

“Jetblue Airlines’ Success Story.” |Business Strategy|Case Study|Case Studies. 2003. Web. 21 Apr. 2015.

“Reference for Business.” JetBlue Airways Corporation. 2015. Web. 21 Apr. 2015.

Schaefer, Steve. “Airline Stocks And The Diminishing Benefits Of Cheap Oil.” Forbes. Forbes Magazine, 6 Apr. 2015. Web. 21 Apr. 2015.

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