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Airlines have benefited from a surge in demand as would-be travelers emerge from the pandemic. But will a potential recession lead to air travel stocks being grounded yet again? David Mau, Portfolio Manager at TD Asset Management, speaks with Greg Bonnell about the outlook for airlines.
Transcript
Greg Bonnell: Things are finally looking up for the airlines as most COVID travel restrictions have come to an end. Travel chaos that we saw at many airports throughout the summer is easing. But will a possible recession now on the horizon wreck that rebound? Joining us is David Mau, portfolio manager at TD Asset Management. Great to have you back with us, David.
David Mau: Nice to be here, Greg.
Greg Bonnell: All right, so let’s dig in. Obviously, the airline industry got hit very hard during the pandemic. Explosion of demand this summer. Chaos at the airports. Everything seems to be going well for now. What do we need to worry about going forward?
David Mau: Yeah, look, you’re right. I mean, air travel has been very robust since basically the beginning of the year. I mean, the spring was great. Summer was even better. It looks like the third quarter, which just ended a few days ago at the end of September, is also going to be pretty strong. So based on the numbers that we’re seeing and what the airlines are telling us, the fourth quarter going into the holiday season is also looking very, very robust.
Travel bookings, both for leisure and business, those fares are being snapped up. And we know that air ticket prices are basically higher than they were prepandemic. So I mean, all in all, it looks like a good year for the airlines. The outlook looks pretty decent. What is uncertain is what’s around the corner in 2023 if we’re headed into a recession. If this first wave of pent-up travel demand has now passed, what does that also mean for next year?
But I mean, the good news is the IATA, which is the airline industry association, predicted 2022 is going to be the first year since the pandemic began that airlines are going to be profitable. So it’s been three years since airlines have turned a profit. And it looks like this year, they’ll finally be able to do that.
Greg Bonnell: And when we think about the return to travel this year, it seemed that the leisure travel was the first thing to resume. People said, well, there’s no restrictions. I can fly here. I can do this. Good, I’m going to do it because I haven’t been anywhere for a while. Business lagged a little bit. From what you’re saying, it sounds like business is picking up too. How did those two different silos of whether you’re traveling just for pleasure or a business react to bad economic times? Did companies cut back pretty dramatically?
David Mau: Companies do cut back dramatically. But I mean, I think for regular leisure travel, if you’re losing your job or you’re getting fewer hours at work and you’re also being impacted by high inflation — so prices for other things are going up. Vacations are one of the first things that you cut, right? So that’s obviously going to be impactful. For companies — right now we’re seeing a lot of companies talking about — starting to talk about layoffs or cost-cutting measures. So that is actually even might be even more impactful for the airlines because travel is only a small part of the overall passengers. But it’s a big part of the airline’s profit.
Greg Bonnell: Now, anecdotally, I’ve heard that as far as the demand goes right now, there are perhaps not enough seats to fill all that demand. And people are getting incentives to say, hey, if you don’t get on this flight, you can get on a later flight. We’re going to give you this money. It seems that they could benefit by bringing more seats online, but that sounds like a risky proposition given all the uncertainty.
David Mau: Yeah, and in general, I think North American airlines, European airlines have kept their capacity lower than what it was prior to the pandemic. I think in most cases, airlines are about 5 to 10– flying 5% to 10% fewer flights than they used to. But those flights are full. They’re more than 100% full, right? So what you just mentioned, flights being oversold. And if there’s 300 seats available on a plane, the airline will sell 310 seats and hope 10 people don’t show up.
But what we’re seeing is that all 310 people are showing up. And then there’s going to be 10 unlucky people who paid for their flight and are not going to get to where they’re supposed to go. So as the airlines keep this capacity lower than what normally was in the past, they’re actually able to operate with fewer staff, right? And we all know that there’s airlines are short on staff both in the planes and on the ground, right?
A lot of the pilots that left over the last two or three years haven’t come back to the industry. Some have retired. Some have moved on to different careers. And it takes a really long time to train a new pilot. So there’s a pilot shortage going on right now. So if the airlines can manage at current capacity levels and still make money and fly flights that are 100% full, they’ll probably continue to do that for at least a little while.
Greg Bonnell: Does that put them in a better position if we do end up in a recession? I only think that it’s been pretty well telegraphed from the central banks what they’re trying to achieve. And that has been pretty well-telegraphed from the people who make economic predictions that they think that you can’t avoid a recession if the Fed– our central bank, the others are really serious about bringing inflation down. But if you get that warning, can you prepare for it as an industry? Because I just think about the pandemic and how everyone, including airlines, were just blindsided by it.
David Mau: Yeah, everyone was obviously caught off guard. I think with these lower capacity levels, when the downturn does come, the airlines will have less this work in terms of reducing even more capacity, right? So for now, it’s probably a good thing.
Greg Bonnell: Fuel costs obviously in prepandemic times. If I was talking about the airlines, you’d always be worried about– it’s a huge expense for them. There’s been a lot of, I guess, volatility in that space as well. Yesterday, we had Justin Flowerday on the program because he said, I can sit here and make a case for $60 oil. I could sit here and make a case for oil above $100. How does the airline industry deal with that?
David Mau: Yeah, I mean, a lot of the airlines will have some kind of commodity hedging programs in place so they’ll hedge the price of oil. But the thing is not everyone does it. And not everyone hedges 100% of their oil exposure because, like you said, oil price could go up, or it could go down. So they want to be in the middle. They don’t want to completely hedge and then miss out on potential upside if oil prices come down. So depending on the airline and what their program is, some airlines will be more– like, more or less affected by the volatility in oil prices.
Greg Bonnell: I understand you were on a trip to Europe recently. And obviously different geographies are going to feel different amounts of pain in a recession depending on what’s happening geopolitically. Europe obviously has a pretty unique situation given the crisis in Ukraine.
David Mau: Yeah, yeah, I mean, European companies face the same challenges that North American companies are facing right now — high inflation, higher prices, higher interest rates. The one additional headwind that they have right now is their dependence on Russia for natural gas. And natural gas is a big part of what they use for heating and for running their factories.
And so obviously with the sanctions on Russia right now and Russia not providing the same amount of– the same volume of gas that they did to Europe in general and Germany in particular, it’s creating an additional headache and a lot of uncertainty for companies there and not just for companies, for households as well that they’re unsure how they’re going to heat their homes this winter.
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