Is This the Real Turning Point for Aviation Stocks?

Money flocked to the sector after February, as vaccination campaigns led to a sharp improvement in ticket sales. On top of hopes of pent-up demand for summer travel, carriers were expected to emerge from the crisis with lower unit costs, having cut as much fat as possible.

When the summer actually came around, though, it became apparent that there was some wishful thinking baked into the trade.

One problem was that an excessive focus on bumper U.S. numbers obscured the havoc caused by coronavirus variants in developing nations, which ended up affecting domestic U.S. traffic too. The long tail of the pandemic has delayed the reopening of transcontinental routes, pushed back the return of corporate travel and kept global seat capacity stagnant.

Moreover, many carriers, especially in Europe, likely had to keep fares low to lure vacationers to a handful of available destinations; coming third-quarter reports will shed light on just how low. The cutthroat nature of the airline business means it isn’t a straightforward “reopening trade.” American airlines have already announced big fleet expansions and cabin refurbishments to tempt business travelers back. The consequent 17% growth in U.S. domestic narrow-body seats between 2020 and 2023 could end up having a big impact on the fares passengers pay to fly a mile, according to estimates by Sheila Kahyaoglu at Jefferies.

A final summer lesson was that quickly bringing aircraft and staff back involved more expenses and headaches than expected, to the point that analysts are rethinking their thesis of permanently lower costs. For most of this year, consensus unit-cost forecasts for the top-three U.S. legacy carriers for the next two years have been consistently reduced, but recently they have started to rise again, figures from Visible Alpha show.

And yet, we seem more likely to be at a genuine turning point now than before the summer. Airline capacity across countries has roughly tracked vaccination rates this year, and the percentage of the world population that has received at least one dose is finally approaching 50%. Cases appear to have peaked in the U.S., which has said it would reopen for European travelers sometime in November.

With hints that other travel barriers could soon fall and the additional support of rising bond yields, aviation stocks may have fuel left to burn during the coming earnings season. The numbers themselves will look stellar relative to last year’s washout third quarter: Wall Street analysts expect the S&P 500 industrial sector to post earnings growth of 65%, of which carriers are expected to contribute three-quarters.

Still, best-in-class names like Delta Air Lines, Southwest Airlines, Airbus and Ryanair seem like the safest way to profit from any positive market sentiment. In aviation, too much bargain hunting often puts investors in a tight spot.

Write to Jon Sindreu at jon.sindreu@wsj.com