By Rajesh Kumar Singh

CHICAGO (Reuters) - U.S. airlines appear to have rediscovered their mojo, thanks to a sharp reduction in capacity that plagued the market this summer. Airfares have turned higher, and airline stocks are now outperforming the broader market.

That improvement was one reason why American Airlines lifted its full-year profit forecast. It led to a surprise third-quarter profit at Southwest Airlines and has put Delta Air Lines on track to deliver one of the most profitable fourth quarters in its history.

The NYSE Arca Airline index has gained 23% in the past three months, outpacing an 8% jump in the S&P 500 index.

It's a reversal from this summer when excess supply of seats in the price-sensitive end of the market forced carriers to discount fares to fill their planes, hurting earnings.

Airlines have aggressively reduced growth plans since then. Annual domestic seat growth slowed to 1.9% in the current quarter - the lowest rate after the COVID pandemic - from 8.3% a year ago and 6% in the June quarter, according to data from TD Cowen.

Capacity growth is estimated to slow next year as well.

"People are trying to ensure that their capacity is lined up with the amount of demand they see for their business models," American's CFO Devon May said in an interview.

Aircraft delivery delays have also put a cap on the industry's growth plans, May said. With jet production taking a hit due to a strike by Boeing's factory workers and Airbus' supply chain challenges, the cap is not expected to be lifted anytime soon.

A sharp slowdown in capacity, meanwhile, has boosted airlines' pricing power. U.S. inflation data shows airlines fares rose at their fastest clip in 18 months in September. In the current quarter, domestic fares are up 9% from a year ago, according to data from Raymond James.

'MORE BULLISH ON AIRLINES'

United Airlines CEO Scott Kirby this month said the industry has reached an "inflection point," and the exit of "unprofitable" capacity would kick off a multi-year run of profit growth that airlines enjoyed in the last decade.

"The only question now is how much margins expand compared to what happened in the 2012 to 2014 time period," Kirby said on United's earnings call.

At that time, low growth propelled operating margins of U.S. carriers to over 11% in 2014 from under 6% in 2012, sparking a 300% rally in airline stocks in those three years.

After the pandemic, airlines struggled to fire up their earnings despite strong travel demand, hurting their equity performance.