We all know who are the big losers from the oil price plunge.
Oil producers. Oil services companies. Dodgy regimes that rely entirely on oil for power, influence and to maintain social order.
But who are the winners? What do you buy to benefit? That’s a trickier question, because the gains from cheap oil are distributed more widely.
Consumers will buy more goods with the money that they’re not spending on heating or at the pump. But even then, this will be spread across the entire retail sector, rather than focused on one or two specific companies.
However, there’s one obvious and major exception – the airlines. Crude at $60 a barrel is one of the best Christmas presents they could have received.
But which airline is the best bet?
Here’s why falling oil prices are so good for airline stocks
Today’s jets need roughly half the amount of fuel that the earliest models did in the 1950s. In fact, if you listen to airlines, a plane gets better fuel efficiency per seat than some cars.
Of course, that’s assuming the plane is full and the car is not. And given the huge distances people fly, it doesn’t matter anyway – it’s still an awful lot of fuel.
A typical plane trip between London and New York in a 777 will burn around 44 tons of fuel – more than 50,000 litres. So it’s no wonder that fuel accounts for around a third of a typical airline’s running costs.
And that’s why airline executives must be feeling in a good mood coming up to Christmas. Because since September, the price of jet fuel has dropped by a third.
US airline Delta reckons this has saved the company $1.2bn.
Of course, not all of this is pure profit. Eventually you’d expect lower fuel costs to be passed on to passengers through lower ticket prices. But that takes time.
Meanwhile, mergers and ‘alliances’ between airlines have reduced competition in the industry. A grand total of four operators control most of the US market. And the fact that many airlines plan on the basis of long-term fuel price projections further reduces the chances of a price war breaking out.
Perfect timing for leaner, meaner airlines
This is all coming at the perfect time. The pressure of a long period of high oil prices has forced the industry to become leaner and more efficient, in order to eke out a profit with oil above $100 a barrel.
Some airlines in the US have been driven to the bankruptcy courts to renegotiate wages and pension schemes. Less radical measures have included cutting back on routes that don’t make enough profit, and offering optional services that customers are willing to pay extra for.
The demand side is also looking good. Airline industry body IATA notes that growth in Asia is very strong, especially in China. While things are a bit slower in more mature markets, it thinks that global passenger numbers will rise by 7% in 2015, to over 3.5 billion.
One remaining concern is the amount of debt that airlines have on their balance sheets. This is a big concern in the US in particular, given that the Fed is expected to gradually raise interest rates from current historically low levels.
However, the good news is that carriers have used the low rate environment to get their liabilities under control and to cut their borrowings.
Which is the best airline to buy?
So which is the best bet? We like American Airlines (NASDAQ: AAL), the largest airline in the US after its merger with US Airways. The process of integrating the two airlines and cutting back on route duplication should produce substantial cost savings that will boost margins in the medium term.
The company’s bold decision to scale back its fuel price hedging in September should be profitable as long as oil prices stay down. It should also give it a price advantage over rival Delta, which made the opposite decision (and which actually owns a refinery).
American is also looking to expand into Asia, to take advantage of surging demand. It already operates some code-sharing agreements with Asian airlines, while it is increasing the number of direct flights from the US to major cities like Beijing.
However, the most attractive thing about the stock is the valuation. It’s trading at only around six times 2015 earnings.
If you’d like to know more about how to benefit from falling oil prices, you can take a look at my colleague John Stepek’s recent story on the topic. If you’re not already a subscriber, get your first four issues free here.