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Airlines are incredibly cyclical businesses whose fates depend on the current state of the economy. Although the airlines have been flying lately with shares of Air Canada (TSX: AC)(TSX:AC.B) and WestJet Airlines Ltd. (TSX:WJA) soaring ~101% and 18%, respectively, over the past year, such cyclical upswings are usually followed by severe crashes should a recession show its ugly face.
Airline stocks: A nightmare to own during economic downturns
When times are tough and money needs to be preserved, the travel budget and airfare expenses are usually the first things to be cut. Airfare is absurdly expensive for most of us, and, in most cases, it’s a luxury, not a necessity. Besides, who could really enjoy travelling if they’re struggling to make ends meet?
Because of the high degree of cyclicality in the airline industry, all airline stocks, regardless of their efficiency, usually lose more than half of their value in the event of a severe market-wide correction, like the Financial Crisis. Unlike most other stocks, airlines have a really difficult time rebounding after recessions, even once the economy has recovered and most other stocks have fully rebounded.
Simply put, airline stocks are not good long-term holdings; they’re medium-term trades at best, because profits usually go out the window once the airlines face turbulence caused by an economic downturn. We’re in the midst of one of the oldest bull markets in a long time, so for many, buying shares of an airline is out of the question, no matter how cheap their stocks get. (They’ve been ridiculously cheap of late with their single-digit price-to-earnings multiples)
Will the airlines of tomorrow be more recession-proof?
Airlines are finding ways to become more efficient. Aircraft are becoming more efficient, and with the rise of ultra-low-cost carriers (ULCC), like WestJet’s Swoop, it’s possible to trim ~40% off the price of your typical airfare. With such a ULCC, you get the bare-bones essentials, so if you want additional services that are usually complementary, you’ll need to open your wallet.
In addition, you’ll be cramped into a smaller seat with less legroom. If you’re fine with several hours of discomfort, then you stand to realize a huge amount of savings!
If another full-blown recession were to happen, the lower airfare would entice typical coach travelers to continue to fly, but on an ULCC to save money for the rainy days ahead. After all, an uncomfortable flight is better than no flight, especially for those who wish to visit family members in other cities during tough times.
Is a ~40% reduction to airfare enough to keep Canadians traveling during tough times?
We’ll have to wait and see, but one thing, I believe, is for sure: WestJet is far better prepared to weather the next economic downturn with Swoop.
Although the airlines are still cyclical, I believe ULCC flights could make airline stocks easier to stomach for long-term investors.
Stay smart. Stay hungry. Stay Foolish.
