Is It Time To Short This Industry Favorite?

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A combination of capacity growth, higher fuel prices and worries about the health of the global economy have sent airline stocks skidding this year. The US Global Jets ETF (NYSE: JETS (http://www.streetauthority.com/stocks/JETS)) is down 10% and many of the major carriers are down upwards of 20% since the beginning of the year.

Investors are now skittish about shares that have popped triple-digits over the last five years in an industry notorious for cyclicality and heavy competition.

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Taking a closer look at the data reveals some broad differences in outlook among the individual names and an opportunity to profit from the current selloff. Capacity growth could moderate in some routes and oil may have topped out for the year.

One heavy-weight is trading for nearly half the valuation of its peers and is taking advantage of the situation to buy up its shares.

Diverging Outlooks For Regional Versus International Carriers
The Air Transport Bureau reported in May that available seats per kilometer, the industry metric for capacity, grew by an annualized 9.6% in February on a year-over-year basis. The increase was significant because it was the first time in more than a year that capacity growth had outstripped passenger traffic. Airlines were taking advantage of strong passenger demand and low fuel prices by significantly increase their number of flights.

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Combined with fears of higher fuel prices on the rebound in oil since mid-February, capacity growth has helped send the airlines into a tailspin. If capacity growth continues to outpace traffic, the carriers could get sucked into a price war from which nobody benefits.

But within the larger airline industry, the outlook may be diverging between regional carriers and their larger international rivals. Regional carriers like Southwest Airlines and JetBlue are continuing to expand capacity through 2016, while larger international carriers are planning on slowing capacity growth.

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The four largest regional carriers by market cap have provided 2016 guidance to increase capacity by up to 11% on average. Capacity growth this year at the three largest international carriers is expected to be between 1.5% and 2.5% on average. This could support pricing for the international and transcontinental markets while regional pricing will remain more competitive.

Despite sluggish global economic growth, the airlines are recording very strong passenger traffic growth. Global passenger traffic increased 8.6% on a year-over-year basis in February, its second consecutive month of higher YoY gains. The North American market booked 9% growth in February and all six global regions reported growth of 7% or more.

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Oil prices seem to have stalled out around $50 a barrel on the second straight week of rising numbers of oil rigs, which threatens renewed production. The price of crude has nearly doubled since its February low, and $50 per barrel could be an important psychological barrier to stabilize production levels, holding prices for crude and jet fuel in stasis.

Large international carriers will be biggest beneficiaries of dollar weakness when second quarter results are announced. The greenback fell throughout April and has recently given back gains made in May. Any further weakness in the dollar throughout the year could provide upside surprise as the larger airlines translate international profits.