By Rajesh Kumar Singh
CHICAGO (Reuters) -It should be the best of times for U.S. airlines with a travel boom still going strong, but investors are nervous demand may soften as the economy falters, making it harder to protect profits from soaring costs.
Those concerns have battered airline stocks even as earnings reports point to a continuing consumer appetite for travel. Shares of United Airlines fell about 10% on Wednesday, dragging down the broader the NYSE Arca Airline index, after the Chicago-based carrier forecast lower-than-expected fourth-quarter profit on rising expenses.
The shares, however, recovered on Thursday following American Airlines (NASDAQ:AAL)' comments that domestic travel demand remains "steady," and the bookings for holidays are stronger than last year.
"It's really a demand-driven business" said Brian Mulberry, client portfolio manager at Zacks Investment Management. "If there's less demand, then obviously less sales means less profitability."
A struggle to get control of operating costs has also called into question rival Delta Air Lines (NYSE:DAL)' goal of generating profit of over $7 per share next year, with some analysts now calling the target aspirational. That is a reason why the airline's shares are down 10% this month even after it posted stronger-than-expected quarterly earnings.
Strong demand from travelers has so far allowed carriers to mitigate inflationary pressure with higher fares. While both United and Delta said travel demand is holding up, double-digit declines in airfares year-over-year suggest airline pricing power has peaked.
Falling ticket prices are raising questions as to how airlines will hedge against cost increases. Delta CEO Ed Bastian last week suggested the industry would be able to pass along increased operating costs to consumers.
But that's easier said than done as analysts say a depletion of pandemic savings as well as high interest rates have crimped consumers' tolerance for high fares.
Airlines are likely to see "a more dramatic negative effect" than in the past if there is any downturn in demand because their cost of doing business has gone up materially, Mulberry said.
While airlines have acknowledged the higher costs, including rising fuel prices, they say passenger revenue points to a healthy demand trend.
"Travel remains a top purchase priority and our core customer base is in a healthy financial position," Delta's Bastian said last week.
United, which has not forecast profit for 2024, on Tuesday similarly said travel demand remains "strong and steady."
Fuel and wage bills accounted for about 50% and 57% of operating costs in the third quarter at Delta and United, respectively. New labor contracts as well as the higher fuel prices mean cost pressures aren't going away.
Rising fuel prices are estimated to inflate Delta's costs by $400 million in the second half of the year. The airline has trimmed its profit outlook for 2023 to a range of $6.00 to $6.25 a share from $6 to $7 per share estimated in July.
Similarly, United projects its average fuel bill will increase by 11% in the December quarter from a quarter ago.
United said it is also facing headwinds from the Israel-Hamas war.
New Chief Financial Officer Michael Leskinen told investors on Wednesday the company's non-fuel operating costs in the fourth quarter would rise by about 1.5 percentage points if its flights to Tel Aviv remain suspended through the year.
Delays in aircraft and jet-engine deliveries have also forced carriers to fly older planes that are less fuel-efficient and spend more on aircraft maintenance.
Delta expects non-fuel costs to be flat to 2% higher year-over-year in the current fourth quarter - a shift from July when it forecast low single-digit declines in the second half of the year.
Melius Research analyst Conor Cunningham said airlines' failure to deliver on their cost target has been "challenging to stomach."