BizWeek: US AQirways is the ticket

[FDJ2]

BusinessWeek Online – Jan 29, 2007

US Airways Is The Ticket

With everything that's going on in airlines, how do you play them? US Airways (LCC ) is the way to go, argue some pros. On Jan. 10 the company raised its bid for Delta Air Lines (DALRQ ) to $10.5 billion. Delta, which had spurned an earlier US Air offer, wants instead to merge with Northwest Airlines (NWACQ ), also in bankruptcy. The Street isn't optimistic that US Air will win out because Delta management and labor are so hostile toward US Air. No matter. "With or without Delta, US Airways will be a winner," says Vince Carrino, president of Brookhaven Capital Management, which owns shares. "If it fails to win Delta, US Air itself will be a target," he believes. Its assets, particularly its extensive domestic routes, should attract the other majors, including American (AMR ), Continental (CAL ), and United (UAL ), says Carrino. Daniel McKenzie of Credit Suisse (CS ) isn't so sure US Air will be an easy target, but he rates it a "buy," based on valuation alone. It is cheap, he says, so he has raised his 12-month target for the stock, already up from 37 in August to 58.79 on Jan. 17, from 72 to 76. US Airways has other options, he notes, such as buying some Northwest hubs to complement its domestic structure. McKenzie figures earnings will jump to $7.70 a share in 2007 from an estimated $5.59 in 2006, vs. a loss of $5.99 in 2005. Another bull, Ray Neidl of Calyon Securities, has raised his rating from "add" to buy, based on strong demand and stable oil prices. If a merger happens, he says, "it will add momentum" to the stock.

 

[labbats]

Why would you invest in airline stock when the casino gives you free drinks?

 

[EWR_FO]

Why would you invest in airline stock when the casino gives you free drinks?

That should be a flight bag sticker.

 

[spinproof]

Why would you invest in airline stock when the casino gives you free drinks?

Of all the postings that have gone before this is the most astute!

 

[humuakalaka]

Why would you invest in airline stock when the casino gives you free drinks?

Well said Labbats, well said.

Yahoo! Finance posted a surprisingly bullish USA Today story this morning on the heels of American Airline's (AMR) announcement that it had turned a profit for the first time in quite some time. It even cited an industry analyst who expects industry profits to total $5 billion this year! Now before we dump our BRK shares to buy AMR stock, let's calm down, take a deep breath and think about this situation.
Face it. Airlines are losers and will never make a decent investment of any kind. Even the stock of the strongest airlines, Southwest (LUV), is now a mediocre investment at best. Although it has been a great investment over its lifetime, it has substantially underperformed the market over the last five years and, with the other airlines now trying to mimic LUV's low-cost model, it seems certain that its competitive advantage will begin to deteriorate. More on that later.
A quick overview of any airline's balance sheet immediately reveals the biggest problems they face. First of all, each airline employs an enormous amount of capital relative to its income. This makes for lousy returns and destroys value. Take American for example. This company has about $30 billion dollars invested in it, after allowing for the negative retained earnings account that has resulted from years of losses. Now, American is barely profitable, but for now let's make the very generous assumption that it earned as much as the most profitable airline, Southwest, earned last year, $500 million. This would make its ROIC a paltry 2%.
Meanwhile, the company is certainly paying no less than 7% on its $14 billion in long-term borrowing, making their annual cost of debt at least a billion dollars, far more than the assumed $500 million in income. This means that even ignoring the cost of equity, and even assuming the company is far more profitable than it really is, it would still be destroying value at a rate of more than $500 million per year.
But forget about all that cost of capital talk, before this most recent period the company wasn't even turning a profit. The reason for this is much simpler. The costs exceed the revenue. I will even go so far as to say that this is unavoidable for airlines. You see, as much as the companies would like to differentiate themselves, the typical airline passenger makes his purchase decision based exclusively on price. This makes an airline ticket merely a commodity and eliminates nearly all the pricing flexibility the airline has.
Thus, the revenue of the company is out of the company's control. Meanwhile, the company's costs are just as uncontrollable and generally fixed, as they consist overwhelmingly of either a) depreciation of those expensive airplanes which must be maintained and eventually replaced or b) fuel costs. What we are left with is a company that can't control its revenues or its costs. No wonder these businesses never make any money.
Now, to make matters even worse, consider the fact that these airlines habitually file bankruptcy. The airline industry is one of the few in which firms are generally able to enter and emerge from Chapter 11 time after time. There was a great WSJ article a while back (called “Red Eyes: For Airlines a Shakeout Runs Into Heavy Turbulence,” Sep 19 2005, A1) that suggested the following: Airlines will continue to lose money and operate inefficiently as long as the bankruptcy process allows them to survive despite their inefficient operations. That is, the Darwinian nature of a capitalist system ought to weed out the weakest firms and allow only the fittest (the most efficient) to survive. But the U.S. bankruptcy system prevents this from happening by allowing firms to habitually rely on it for survival. An interesting assertion, but the article gave no supporting evidence so I can’t really assess its validity.
Regardless, an investor who purchases an airline stock must be prepared to deal with a high risk of bankruptcy, in which case he could lose 100%. Add this risk to a commodity business with huge fixed costs and a gigantic capital base and I just don’t see where the value will come from.

 

[lowecur]

"If it fails to win Delta, US Air itself will be a target," he believes. Its assets, particularly its extensive domestic routes, should attract the other majors, including American (AMR ), Continental (CAL ), and United (UAL ), says Carrino. Daniel McKenzie of Credit Suisse (CS ) isn't so sure US Air will be an easy target, but he rates it a "buy," based on valuation alone. It is cheap, he says, so he has raised his 12-month target for the stock, already up from 37 in August to 58.79 on Jan. 17, from 72 to 76. US Airways has other options, he notes, such as buying some Northwest hubs to complement its domestic structure. McKenzie figures earnings will jump to $7.70 a share in 2007 from an estimated $5.59 in 2006, vs. a loss of $5.99 in 2005. Another bull, Ray Neidl of Calyon Securities, has raised his rating from "add" to buy, based on strong demand and stable oil prices. If a merger happens, he says, "it will add momentum" to the stock.

These guys always like to complicate things. You go with the (2) carriers that want to merge with someone (UAL/USAIR). Glenn Tilton wants to cash out, and Doug will be more than happy to accomodate him. The entity will remain UAL. CAL will want in, but they don't have the Wall St bankers that DP has. He will take DP's offer and run. This will be the catalyst for the rest of the industry as musical chairs will leave someone without a seat.

imp:​