Trading in October assuaged the market’s worst fears, and the industry is ending the year in good shape.
Shares in United Airlines (UAL 2.81%) rose by a remarkable 37.2% in October, according to data from S&P Global Market Intelligence. The move comes as a consequence of a relief rally in the airline sector and needs to be looked at in the context of what’s happened in the industry over the years and how investors tend to look at the sector.
A turbulent year for United Airlines’ stock
The following chart demonstrates that optimism over the stock and the sector was high going into the spring, only to decline precipitously over the summer and make an exceptional recovery over the past three months.
The moves reflect the volatile and cyclical nature of the airline industry. It’s an industry with relatively high fixed costs and one in which airlines have traditionally been slow to make capacity cuts in response to waning demand. As such, when demand starts to slow or overcapacity appears in the industry, ticket prices can be cut, leading to a steep fall in profitability.
That’s what the market was worried about over the summer, when growth in routes led to overcapacity in the industry. Throw in increased costs, and you have a recipe for earnings to come under severe pressure. A look at United Airlines’ second-quarter results, ended June 30, shows its total revenue per available seat mile declining 2.4% year over while its non-fuel cost per available seat mile rose 2.1%.
As if that wasn’t bad enough, the industry was suffering from overcapacity, and United Airlines was also hit with the CrowdStrike software update issue that grounded flights in July.
Put all of these things together, the pessimism over the summer was understandable.
Image source: Getty Images.
A recovery in sentiment and underlying metrics
Rational investors understood that the third quarter was never going to be a great one for United Airlines. Indeed, adjusted operating income declined by 11.8% to $1.56 billion year over year.
Still, the critical point is that airlines acted rationally and adjusted capacity where necessary, leading United Airlines to exit the quarter in better shape than it entered it. CEO Scott Kirby noted on the earnings call: “As the company expected, revenue trends improved as the industry reached an inflection point in the quarter with unprofitable capacity exiting the market. Domestic unit revenue was positive year over year in August and September.”
This narrative matches the one from Delta Air Lines‘ management, and the two are the best stocks in the airline industry.
As such, the market is pricing in strong growth for United Airlines in 2025, with Wall Street analysts penciling in 18.5% growth in earnings and trading on less than eight times expected 2024 earnings. The stock remains a good value.
Lee Samaha has no position in any of the stocks mentioned. The Motley Fool recommends Delta Air Lines. The Motley Fool has a disclosure policy.
