How does the U.S. airstrike on an Iranian military leader impact the share price of airline stocks in the U.S.? Hint: It’s not because people are suddenly canceling their vacations to Tehran.
It’s oil prices.
The Islamic Republic of Iran (“Iran”) is an oil juggernaut. They are the third-largest producing member of OPEC and have the fourth-largest proven oil reserve in the world. History shows it’s sensible for investors to get jumpy when turmoil hits the Middle East. The Iranian Revolution of 1979 led to a spike in oil prices across the globe, triggering a recession in the United States.
On Friday, crude oil prices rose by 3%.
The Problem For Airlines
Fuel costs represent a significant portion of airlines’ total cost structure. For American Airlines, the cost of fuel represented 24% of total operating expenses in 2018.
Many airlines try to limit their exposure to volatile oil prices by “hedging”. What does that mean? Airlines enter into contracts with financial institutions to effectively lock-in oil prices for a certain period of time. This helps protect short-term profits from market spikes, such as the one we saw on Friday.
But not all airlines hedge. American Airlines chooses not to hedge their oil cost, and its shares were the worst hit of the airline sector on Friday, down over 4%.
Airline Big Picture
Airline stocks had a disappointing 2019 relative to the broader market.
- The Big Trend: The grounding of Boeing’s 737 MAX put a dent in the profit of nearly every major airline. American, United, and Southwest all have large 737 MAX fleets and have been forced to cancel thousands of flights. The economic losses have been substantial. American, for instance, took a $540 million hit to pre-tax profit in 2019.
Delta, which doesn’t operate the 737 MAX, had the best share price performance in 2019 out of the major airlines.
The Inside Scoop
Over the long term, many analysts believe that airlines won’t be impacted by higher oil prices. How? Airlines are typically able to pass-on higher fuel costs to the consumer. It’s the short term volatility, particularly when not properly hedged, that is causing turbulence.