We all know about the 787 by now — The Boeing Company (NYSE:BA)‘s proof of concept that aircraft designed around energy efficiency can translate into better profits for airlines. That’s great, but we also know that the 787 only flies long-range — what about the huge market for domestic routes?
Enter the 737 MAX. You’ve got to see this thing. This is a work of art in the the sky that shareholders can appreciate more than a Monet.
Have you ever seen wingtips like that? Did you notice the tapered tail section? To say the least, the plane gets excellent fuel economy … but more on that later. The question now: how can airline investors benefit?
The rationale
The answer to this question starts with a look at Southwest Airlines Co. (NYSE:LUV)‘s 2012 annual report, where CEO Gary Kelly gives early and specific mention to fleet modernization as a way of driving increased profits. Central to his commentary: acquisition of a whopping 150 737 MAX aircraft for delivery into operation during 2017.
Competitor United Continental Holdings Inc (NYSE:UAL)‘s 2012 report similarly touts advances in energy efficiency as a vital way to counter rising fuel costs, and along these lines, United has committed to an order of 100 737 MAX units for delivery in the same time frame. Orders of such large quantity infer that execs at Southwest and United have got their strategic thinking caps on, and if I had to guess, I’d say that their strategy centers around asset efficiency and cost-cutting. Buying so many expensive airplanes seems a bit counter-intuitive to that end, but LUV and UAL have learned where new planes cost less than maintaining the old birds that guzzle fuel. Why else the emphatic focus on fleet modernization in the annual reports?
Speaking of assets
Considering all this talk about changes in airline fleet composition, let’s take a look at some return on asset figures, an important metric considering the asset-intensive nature of the industry.
At a bird’s-eye view, Southwest and United’s share prices do seem to trace a positive correlation with their respective Return on Asset (ROA) figures. Drilling down a bit further, Southwest’s ROA suffered its biggest decline from mid-2008 to mid-2009 — and so did its share price. As ROA improved from -1% in its 2009 trough to an average of 2% for the majority of 2010-2012, its share price tripled and maintained this level until a third quarter (Q3) 2012 drop in ROA. So far in 2013, the upward trajectory has resumed, coinciding with a move back above the 2% ROA mark.
Data from United shows a similar relationship: a terrible -25% collapse in ROA in late 2009, including an equally horrendous 5-year low in equity value. ROA subsequently rebounded and stabilized to positive levels, and has remained remarkably consistent at around 0.2% in recent years; the share price also bounced back in the same pattern. When I look for similar movements in other industries, from telecom to tech, I generally don’t see such a strong relationship between ROA and stock price as in the airline industry. That said, a move into more efficient assets can bolster net income to a degree where ROA stabilizes or rises, with the expectation that stock price will follow.
