International air transportation companies are poised to suffer as capacity continues contracting to align with flagging demand in numerous industries throughout the world.
In coming days, government-imposed travel bans, rising fear of mingling with fellow travelers and mounting concern that equipment may or may not actually be free of the Ebola virus will curtail individual impulses to purchase air tickets for business and for pleasure.
Bookings during the peak travel period through November and December of this year, and in the typically weak start to the following year, could then evaporate and thereafter start falling dramatically, even if the Ebola crisis is swiftly and credibly contained, which does not seem all that likely at present.
With high fixed costs, leveraged air carriers that enjoy thin profit and cash flow margins even in the best of times will subsequently suffer far more from steep declines in revenue than they will gain from reduction in the cost of jet fuel, which is one admitted benefit arising from the global economic slowdown.
Given these risks, traders likely will sell positions they may hold, especially if they began assembling these starting around March 2009, when surface-level analysis suggests the global economy began rebounding.
Considering geopolitical realities and recent economic history, long-term investors would be wise to join traders in trimming holdings and avoid succumbing to temptation that global airline carriers present pockets of opportunity under current market conditions.
Structural case against airline stocks
Warren Buffett has warned investors with long-term horizons against investing in the airline industry for many years — one area where he and I are in agreement.
Though air transportation retains considerable allure and has numerous admirers in the investment community, now airline companies can create nothing but trouble for investors seeking to allocate capital to safe “stores of value” they believe will steadily and reliably appreciate in worth.
As is the case in many sectors, the airline industry and its suppliers do not have a super-regulator capable of forcing each nation in the world, including the U.S., to comply with a single set of standards, including such important issues as subsidies, accounting principles and environmental pollution.
Consequently, there is always at least one nation that is willing to distort pricing of essential inputs such as equipment, infrastructure and fuel.
Moreover, history in the deregulated era shows that choice routes eventually get picked off when irrational, state-sponsored actors decide to increase global market share, whatever the financial cost.
Meanwhile, wounded players in given markets can also depress fare levels for sustained periods simply to generate cash, even as losses mount, in the vain hope of staving off financial disaster.
In the U.S., where the air transportation industry is less regulated than it once was, most of the largest carriers have experienced bankruptcy, in some cases more than once.
Prudent investors should note that leveraged multinational companies can go from relative calm to panic in mere moments.
Specter of rising interest rates
Since 1981 in the U.S., nominal interest rates declined and consumers borrowed more, sometimes to fund luxuries. Access to more debt at ever-declining interest rates became a virtually unquestioned constant in daily life.
Reversal in the trend in nominal interest rates and tighter credit standards would hurt airline stocks more than most.
In the capital-intensive “value chain” involving equipment vendors, airline carriers and consumers, rising interest rates and reduced access to debt would crimp demand and create potentially steep losses in multiple places.
Few airline carriers have long histories of reliably paying rising cash dividends on their common shares — fewer still are likely to be acquired at premium valuation levels.
Unless you take pleasure chasing danger, avoid airline stocks until we know much more about Ebola and see clearer signs pointing to a rebound in the global economy.
October is a dangerous month — for airline stocks, 2014 seems even more dangerous than 2008, 1989 or 1987.
• Charles Ortel serves as managing director of Newport Value Partners (NewportValue.com), which provides economic research to executives and to investment firms.
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