Global Airline Equities Underperform when US Dollar Strengthens

21 August 2018, Global – The recent strengthening of the US Dollar is negative for the global airlines and their share prices have historically underperformed when the USD is strong. This is mainly because the airlines tend to have more USD-denominated costs than USD-denominated revenue. Moreover, their aircraft capex is also paid in USD and often financed with USD debt or USD leases. For US carriers and airlines whose home currencies are pegged or highly correlated with the USD, the stronger USD results in weaker foreign currency translated revenue. Although some carriers have forex hedging in place, the impact will not be completely mitigated.

Global airlines’ local currencies have weakened against the US Dollar year-to-date, apart from the Japanese Yen 

The US Dollar has strengthened 4% against the global airlines’ local currencies on average year-to-date. The Turkish Lira (down 38% ytd), Brazilian Real (down 15%), Russian Ruble (down 14%), Indian Rupee (down 9%) and Chilean Peso (down 8%) have been the weakest performing currencies so far this year.

Chart: Global airlines’ local currencies have all weakened against the US Dollar year-to-date with the exception of the Japanese Yen (2018)

Global airlines’ local currencies have all weakened against the US Dollar year-to-date with the exception of the Japanese Yen (2018)

Stronger US Dollar inflates fuel costs and aircraft-related payments

Further strengthening in the US Dollar would be detrimental to the global airlines’ financial performance going forward as they have more USD-denominated costs than USD-denominated revenue.

In addition, their aircraft capex is also paid in USD and often financed with USD debt or USD leases so the aircraft they purchase or rent are becoming more expensive in local currency terms.

In the case of the US carriers and other airlines whose home currencies are pegged or highly correlated with the USD, the stronger USD results in weaker foreign currency translated revenue.

Airlines also have to book foreign exchange translation losses when the USD strengthens 

Moreover, for airlines which fund their aircraft capex with a sizeable level of USD debt, this results in unrealized foreign exchange translation losses (gains) that the airlines are required to mark to market and book in their financial statements at the end of each reporting period when their local currencies weaken (strengthen) against the US Dollar.

For highly leveraged airlines with substantial US Dollar debt levels, this forex loss (gain) can be disproportionately larger than their recurring earnings impact from the stronger (weaker) US Dollar.

Although it is a non-cash item and could potentially reverse if the local currency rebounds against the US Dollar in the future, the stock market has historically reacted negatively (positively) to global airline stocks when the US Dollar strengthens.

Some airlines, such as the Big 3 Chinese carriers Air China, China Eastern and China Southern Airlines have significantly pared down their US Dollar debt exposure in the past 3 years to mitigate this forex risk and non-cash accounting impact.

Investors tend to avoid global airline equities when the US Dollar is strengthening

Historically, the global airline stocks tend to underperform when the US Dollar is strong. Based on our correlation analysis of their daily market price movements for the past 3 years, the share prices of Wizz Air, easyJet, Azul, LATAM, Nok Air, Avianca, GOL, Air China, WestJet and Alaska Air are the most strongly correlated with the strength of their local currencies and could suffer the greatest impact given the stronger US Dollar.

Chart: Global airlines share price performance correlation with the strength of their local currencies (2015 to 2018)

Global airlines share price performance correlation with the strength of their local currencies (2015 to 2018)

Airlines whose share prices tend to react less to their local currency movements are the domestically listed Chinese and US carriers

By contrast, the share prices of domestically listed Chinese carriers (including Hainan Airlines, Spring Airlines, Juneyao Airlines) as well as the US carriers (including Delta Air Lines, Southwest, Spirit) do not have any meaningful correlation with their local currency movements.

Key exceptions – Japanese and Australian/New Zealand airline stocks tend to outperform when the US Dollar strengthens

Interestingly, the Japanese airlines ANA Holdings and Japan Airlines’ share price performance are negatively correlated with the Japanese Yen which seems counter-intuitive since they are also short of US Dollars. This could be due to market expectations of reduced inbound tourism traffic due to the stronger Yen.

Australian and New Zealand carriers Qantas, VAH Holdings and Air New Zealand also tend to outperform when their local currencies weaken against the US Dollar.

 

Note: Stocks with upside of more than 10% based on our fair value are assigned an Outperform rating. Stocks with downside of more than 10% based on our fair value are assigned an Underperform rating. Stocks with upside or downside of less than 10% based on our fair value are assigned an In-line rating. These are Crucial Perspective’s proprietary rating classifications and by no means serve as investment recommendations.

Independent Research Declaration: Crucial Perspective does not own any position in the equities featured in this report nor have we received any compensation for writing this report. 

 

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