High oil prices and overcapacity continue to depress airline profit margins, according to Nigel Ridg...
High oil prices and overcapacity continue to depress airline profit margins, according to Nigel Ridge, fund manager at Deutsche Asset Management. In looking to explain the transport sector's underperformance year to date, Ridge points to the impact of the oil price increases early in the year.
The Bloomberg 500 European index transport subsector fell 87.20% in sterling terms, for the year to 6 November, compared to the overall index returns of -5.02%. Within the sector the top performing company, British Airport Authority, returned 29.43% in sterling terms over the same time period.
Ridge says: "Investors have become concerned about the profit outlook of companies negatively impacted by the price of oil. Transport is a very good example of an affected sector. Airlines are very exposed to the fuel prices."
This has been exemplified by Deutsche Lufthansa, who at the end of October imposed a 4% price hike on internal flights, blaming the cost of oil, he says.
Jeremy Podger, European equities investment manager at Investec, agrees that oil price hikes have been a problem for the sector. He notes: "In a low margin business a 50% increase in fuel costs is significant."
Pricing pressures squeezing down margins are the main concern for the sector, according to Geoff Miller, investment manager at Exeter Asset Management. He says: "There is still a significant overcapacity in the sector. Following the 1997 Asian crisis, flights to the region fell, and thus Asian fleets were used to serve Atlantic routes, resulting in huge overcapacity. Passenger volumes still have not fully recovered but the number of aircraft has continued to grow."
Podger agrees there is a worrying imbalance between the growth of passenger volumes and flight numbers. He plays down the significance of competition from low cost airlines, pointing out that British Airways has its own in Go service.
He says of the likes of RyanAir and EasyJet, have expanded the market rather than taken market share away from the incumbents.
He adds: "The competition is real but limited. "BA has shunned the whole area of short-haul economy flights. It does not provide the profit margins they are looking for. They are now concentrating on higher margin business travellers and long-haul flights."
Podger believes that BA may now offer good value, noting that conditions should benefit BA and other more established players. "The playing field is becoming more level in Europe. BA has a lot of slots in the core London airport system and as the less profitable airlines retreat, BA should do rather well."
Miller says Exeter is overweight transport, but admits the sector is not one he would normally enthuse about. He says the downturn in the first quarter that hit the sector, particularly bus and train companies, meant there were a number of undervalued stocks available.
Miller prefers train and bus companies to airlines, with bus operator Ariba his favourite in the sector. He feels the company is underrated, paying a high yield, with good growth prospects both domestically and on the continent.
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