U.S. Airlines Regain Strength as Capacity Shrinks

By Rajesh Kumar Singh

CHICAGO (Reuters) – U.S. airlines seem to have regained their momentum due to a significant reduction in capacity that adversely affected the market this summer. Airfares have increased, and airline stocks are currently outperforming the broader market.

This improvement is part of the reason why American Airlines (NASDAQ:AAL) raised its full-year profit forecast. A surprise third-quarter profit for Southwest Airlines (NYSE:LUV) and expectations for Delta Air Lines (NYSE:DAL) to achieve one of its most profitable fourth quarters in history are also noteworthy developments.

The NYSE Arca Airline index has gained 23% over the past three months, surpassing the S&P 500's 8% increase.

This represents a major turnaround from the summer when an excess of available seats forced airlines to discount fares, harming earnings.

Since then, airlines have sharply curtailed their growth plans. Annual domestic seat growth has slowed to 1.9% this quarter—its lowest rate since the COVID pandemic—down from 8.3% last year and 6% in the June quarter, according to data from TD Cowen.

Capacity growth is expected to decelerate next year as well.

"People are trying to ensure that their capacity matches the demand they anticipate for their business models," said American's CFO, Devon May, in an interview.

Delays in aircraft deliveries have also constrained the industry's growth plans. Production issues due to a strike by Boeing (NYSE:BA) workers and Airbus' supply chain challenges are expected to persist.

The sharp reduction in capacity has increased airlines' pricing power, with U.S. inflation data showing airfares rising at their fastest rate in 18 months in September. In this quarter, domestic fares are up 9% from last year, according to Raymond James data.

More Bullish on Airlines

United Airlines CEO Scott Kirby (NYSE:KEX) remarked that the industry has reached an "inflection point," suggesting that the exit of unprofitable capacity could lead to multi-year profit growth similar to the previous decade.

"The only question now is how much margins expand compared to the period from 2012 to 2014," Kirby noted on United's earnings call. During that time, low growth allowed U.S. carriers' operating margins to exceed 11% by 2014, up from under 6% in 2012, leading to a 300% rally in airline stocks.

Post-pandemic, airlines faced challenges in boosting earnings despite strong travel demand, negatively impacting their stock performance.

Nevertheless, capacity adjustments combined with a 20% year-on-year decline in jet fuel prices in North America have improved the industry's outlook.

"We are more optimistic about airlines today than we have been in a long time," stated Conor Cunningham, an analyst with Melius Research.

Reduced capacity has made airlines less concerned about delays in aircraft deliveries. Last week, Southwest indicated that its reduced growth plans over the next three years left it with surplus planes, prompting the Dallas-based carrier to plan to sell its aircraft in the secondary market. Similarly, Frontier has postponed taking delivery of 54 Airbus jets, while JetBlue has deferred 44 new jet deliveries from Airbus.

"Every aircraft must continue to earn its way into the network," remarked JetBlue President Martin George.

There is a growing consensus among carriers regarding capacity discipline. Even ultra-low-cost airlines, historically reliant on high growth to efficiently utilize their fleets and minimize operating costs, have moderated their growth strategies.

For instance, Frontier aims for mid-single-digit capacity growth next year, a sharp decrease from an average of 19% growth over the past two years.

"What we are witnessing now is cutbacks, and they will keep going until they meet their targeted margins," said CEO Barry Biffle during a recent analyst meeting. "I believe this represents the most favorable backdrop we've had in perhaps 7 to 10 years.",