Some have said the airline industry has changed. We’ve always been cautious on the structural characteristics of the airline business, and United Continental has reminded us why.
By Kris Rosemann and Brian Nelson, CFA
The US Treasury is scheduled to announce its plans to finance the government’s shortfall over the next three months January 31, and many are forecasting a significant rise in the sale of government paper. 2018 could mark the first year the government will increase Treasury bond sales, and some estimates have the issuance at more than $1 trillion, the highest level since 2010. The current 10-year Treasury yield is ~2.65%, and a significant influx of supply into the Treasury bond market could drive prices meaningfully lower, thus driving yields higher. Speculation that the Treasury could begin offering maturities of up to five years before moving on to longer maturities could exacerbate the trend of a shrinking spread between short- and long-term yields.
Trouble continues for General Electric (GE) as the company disclosed an SEC probe into the process that led to its massive charges related to its insurance business on its quarterly earnings call on the morning of January 24. The firm is also considering “different structuring alternatives, not breaking up the company,” according to GE Capital Aviation Services CEO Alec Burger. GE is looking to remove $2 billion in structural costs in 2018 as it embarks on a massive turnaround in addition to the $1.7 billion extracted in 2017. The company reported strong performance in its ‘Aviation’ and ‘Healthcare’ segments in the fourth quarter of 2017, but its ‘Power’ segment continues to be a source of weakness as segment profit fell 88% from the year-ago period.
In other earnings news, shares of Dividend Growth Newsletter portfolio idea Novartis (NVS) moved higher after issuing strong results for the fourth quarter of 2017. Revenue advanced nearly 5% on a year-over-year basis as volume growth was partially offset by increased competition in its generic business, and non-GAAP earnings per share grew 8% from the year-ago period as productivity improvements more than offset the negative impact of its generics business. The company expects 2018 net sales to grow at a low-to-mid single-digit rate and core operating income to increase at a mid-to-high single-digit pace.
The airline industry is taking a beating after United Continental (UAL) announced plans to increase US capacity at a 4%-6% pace over the next three years along with its fourth quarter report after the close January 23. UAL President Scott Kirby said, “The best way to compete with a low cost carrier is match their prices. Half our revenue approximately comes from customers that are mostly shopping on price. And we cannot ignore half of our revenue, and we can’t let low cost carriers have price advantages in our hubs, and no one chooses to fly on an ultra-low cost carrier, if they can get the same price on United Airlines.” This is only the most recent reminder of the cyclical nature of the commercial airline industry, and pressure on fares in key markets is a likely consequence of the growing capacity.
Read more, “The Bull Case for Airline Stocks?” (October 2017)
Listen to this Podcast, “Warren Buffett Is Back Into Airlines, Should You?” (November 2016)