The airline industry has been a notoriously difficult sector to invest in. Even Singapore’s largest airline carrier, the pride of our nation, has not had a history of outstanding returns. Legendary investor, Warren Buffett, also once said that the airline industry was one that needed a huge amount of capital outlay but had little to no profits to show for it.
However, the airline industry might also have its own upside potential as they operate in a space that is essential and continues to grow as the middle-class population grows. As such, I thought I would write a two-part article on this topic.
The first article will take a look at some of the risks of investing in airline businesses, while in the second, I will look at some simple metrics we can use to assess the competitiveness of an airline company.
So, without further ado, here are three important risks to consider when investing in the notorious airline industry.
Highly linked to oil prices
There is probably no other industry that is as affected by the price of oil as the airline sector. Because of how dependent and how much fuel an airline uses, a slight uptick in fuel price can cause a huge increase in the cost of each trip.
It is estimated that just a $1 increase per barrel of oil can cost the global airline industry an additional $1 billion a year. That is a significant amount of risk that is outside the control of an individual airline company. Even hedging strategies cannot fully compensate their vulnerability to sustained periods of high oil prices. Furthermore, these hedging activities may dent profitability over the short-term and is a costly method to defer risks.
Risks of competition from low-cost carriers
The airline industry has been disrupted by the emergence of low-cost carriers. These low-cost carriers are no-frills airlines that can provide the service at a much lower cost to travellers.
The risks of price-cutting by competitors are more of a problem in the airline industry than any others. This is because travellers are more price sensitive due to the similarities between carriers and little product differentiation.
Even low-cost carriers themselves are at risk to competition, and as a result, we often see companies trying to undercut each other in an attempt to gain market share.
Susceptible to economic downturns
The nature of the airline industry makes it vulnerable to economic downturns. A slight slowdown in the global economy can have a devastating effect on air travel. According to a study published by the International Journal of Commerce, Business, and Management, the 2008 global financial crisis caused premium travel to fall by 25%. Economy travel also took a hit and declined by 9%.
Both the number of business trips and holidays decline during times of economic crisis, and this can have a major impact on the profitability of airline companies.
The Foolish bottom line
The airline industry may be growing at a fast pace at the moment, but the companies involved are exposed to significant risks. Many of these risks are beyond the control of management. It is important to be aware of the risks involved in investing in this sector before making your investing decisions.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.