Long Airlines, Short Oil is Working Again

The U.S. Global Jets ETF JETS debuted at the end of April and for a while there, the lone dedicated airline exchange traded fund flummoxed investors by trading lower in unison with oil.

Fortunately for airline bulls, JETS and oil are diverging in favor of the airline fund. That stands to reason because jet fuel, a petroleum byproduct, is the largest input cost for airlines. Over the past month, JETS is up 5.5 percent while the United States Oil Fund USO has plunged 17.3 percent. Tuesday was a microcosm of that trade when JETS jumped 1.1 percent in a lousy tape for U.S. stocks while USO sank 2.7 percent.

“According to Jim Corridore, an S&P Capital IQ equity analyst, years of consolidation, bankruptcies, and capacity adjustments have given the airlines increased pricing power, which has led to rising industry revenues and passenger yields over the past five years. Fare increases, fewer fare sales and an increased mix of business travelers (who tend to pay more for tickets) contributed to industry revenue growth. Average fares have risen sharply over the past five years and passenger load factors (a measure of how full, on average, flights are) are at record levels for the industry. In 2014, the load factor was 83.4%, up from 83.1% and 82.8% in 2013 and 2014, respectively,” said S&P Capital IQ Director of ETF and Mutual Fund Research in a recent note. 

With oil prices low, JETS potentially has the wind at its back. As Rosenbluth notes, Delta Airlines Inc. DAL could see its fuel costs drop up to 50 percent this year as it “benefits from operating its oil refinery, as well as from lower oil prices, partly offset by losses on hedging contracts entered into at higher fuel prices.”

Delta is the second-largest holding in JETS behind Southwest Co. LUV. Those stocks combine for 24.7 percent of the ETF's weight. JETS is top heavy as its top four holdings – Southwest, Delta, United Continental Inc. UAL and American Airlines Group Inc. AAL – combine for over 47 percent of the ETF's weight.

Investors looking for some all airline exposure without dedicated industry commitment of JETS can consider the SPDR S&P Transportation ETF XTN. XTN is an equal-weight ETF with a 26 percent weight to airline stocks, the fund's second-largest industry weight behind truckers. That is enough to give XTN some leverage to the trend of slumping oil prices.

“From a cost perspective, the U.S. airlines industry consumes about 19-20 billion gallons of jet fuel a year, according to Corridore, so lower oil prices can drive significantly lower costs. For many years, jet fuel has been the largest cost category for most U.S. airlines, eating up about a third of the industry’s revenues. Oil prices were recently around $45 a barrel, down more than 50% from a year earlier,” adds Rosenbluth.

Seven of XTN''s top 10 holdings are airline stocks.