Cheaper Airfares Are Squeezing Airline Stocks

Airlines that focus on domestic flights are being squeezed as Americans embrace travel to Europe over vacations closer to home. Airfares across the industry were down 13.3% in August from a year ago, marking the fifth straight month of declines, according to federal data that is weighted toward domestic flights. The weakening demand comes just as airlines are facing surging jet fuel prices and rising labor costs.

Doubts over whether carriers will be able to raise fares to offset mounting expenses have their stocks in retreat: The U.S. Global Jets exchange-traded fund, which tracks the industry, has gained 5.4% this year on a postpandemic bump but is down 19% from its recent high in July. American Airlines’ stock is down 29% from that peak, while Southwest Airlines is down 24%.

The S&P 500 is up 1.5% over the same period.

“Bigger picture, this is an industry driven by pricing power," said Andrew Didora, senior airlines analyst at Bank of America. “There’s the investor concern that pricing is not going to be there as fuel moves higher."

The pressures come after a tumultuous few years for the industry. Airline stocks plunged after the Covid-19 pandemic essentially shut down travel in 2020, forcing carriers to turn to government aid and borrow billions of dollars to get through the dry spell.

Then as health restrictions eased, people who had built up savings while stuck at home eagerly shelled out to travel again. The pent-up demand—along with labor shortages that limited capacity—drove airfares up by as much as 43% in 2022 from the previous year. Airlines reaped record revenues, and shares of major carriers have more than doubled from their 2020 lows, though heavier debt levels have kept shares well below prepandemic levels.

For now, people are still squeezing onto packed airplanes. An average of 2.4 million passengers went through U.S. airports each day over the recent Labor Day weekend, according to Transportation Security Administration data. That was higher than in 2019.

Where travelers are headed, however, has shifted.

Spirit Airlines, which operates mostly domestic flights, said last week it had to offer “steep discounting" for travel booked from the late summer to pre-Thanksgiving period, and trimmed its third-quarter revenue forecast. Southwest said earlier this month that overall demand was healthy, but that August bookings were on the low end of its expectations.

Investors also worry the postpandemic surge in leisure travel will peter out and that lucrative corporate travel will never fully return. Before the pandemic, business travelers accounted for about half of profits and 12% of traffic for U.S. airlines, according to a McKinsey analysis.

Meanwhile, American Airlines, Delta Air Lines, United Airlines and Alaska Air Group have all warned that costs for the third quarter would be higher than previously forecast.

Airlines are paying roughly 25% more for fuel than they were in July, according to Didora of Bank of America. Labor costs are also set to increase, with new contracts for American Airlines and Delta pilots promising pay raises over a four-year period of 46% and 34%, respectively.

Like other commodities, fuel prices are volatile and a drop could help reverse the recent selloff. Airlines could also try passing higher costs on to customers by raising fares.

But people might no longer be willing to spend as much on trips as their pandemic wanderlust subsides. “It’s always difficult to tell how elastic demand will be," said Chris Raite, an industrials analyst at research firm Third Bridge Group.

Write to Charley Grant at charles.grant@wsj.com