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The managers of U.S. airlines finally have become "more concerned about profits than market share," says Ray Neidl, a senior aerospace analyst at Maxim Group in New York. And that's great news for investors.
The industry broke even in the seasonally weak first quarter, was profitable in the second and probably will earn more than $1 billion in the current one. The respectable results have come despite a 40% jump in jet-fuel prices in the second quarter from the year-earlier level, to more than $3 a gallon.
The improved outlook isn't evident in airline stocks, most of which have been pummeled this year on concerns about those fuel costs and the economy, plus memories of the bankruptcies of carriers including United Airlines,
Delta Air Lines,
US Airways Group and Northwest Airlines over the past decade.
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John Perlock for Barron's
An emphasis on profitability, rather than market share, is lifting the prospects of U.S. airlines. This, in turn, should lift the stocks of the best-run carriers.
Indeed, despite their healthier prospects, airline stocks remain best suited for risk-tolerant investors. "They're the ultimate high-beta, economically sensitive stocks," says Michael Linenberg, the airline analyst at Deutsche Bank. "They're the first stocks that people get out of." High-beta stocks are more volatile than the overall market. Adding to the potential volatility: 2011 airline earnings estimates have fallen since the start of the year, in part on worries that business travel, which accounts for an estimated 65% of carriers' revenue, may be weak. But airline-stock valuations look compelling. And they'll look even more so if fuel costs stabilize -- a distinct possibility, given the likely resumption of Libyan oil exports by year's end -- and the U.S. economy doesn't slide back into recession.
AMR (ticker: AMR), parent of American Airlines, is down 57% this year to about 3.50, not much above its 2009 low. Delta is off 40% to 7.50;
United Continental has fallen 25%, to 18; Southwest has dropped 37%, to 8.25; and
JetBlue is off 37%, to 4.15.
Some of the better plays are United Continental (UAL), Delta (DAL),
Alaska Air Group (ALK),
Southwest Airlines (LUV) and JetBlue (JBLU). All are expected to operate in the black this year. United Continental has an excellent network, including hubs in Newark, San Francisco and Chicago, plus lucrative Pacific routes. Delta is benefiting from the integration of its merger with Northwest. And United and Delta trade at just four times projected 2012 profits.
Alaska Air has industry-high profit margins of 13%, and a solid niche on the West Coast. Southwest has the best balance sheet, and a history of making money in good times and bad, while JetBlue has one of the newest fleets, loyal fliers and a growth strategy keyed to Boston and the Caribbean.
Dismal History
Since the Sept. 11, 2001 terrorist attacks disrupted airline travel around the world, the industry has chalked up big cumulative losses.
AMR, parent of American Airlines, is the group's riskiest stock, because it's losing money, owing to a high cost structure. US Airways Group (LCC) has good management but a relatively weak route network, limited international exposure and near break-even results.
Over all, says Gary Chase, the airline analyst at Barclays Capital: "I don't think the fundamentals are as bad as what the stocks are suggesting. The market is discounting some probability of a global financial crisis."
IT'S UNDERSTANDABLE that investors are down on airlines, because most have significant debt, and their profits are acutely sensitive to changes in revenue. While most industry executives sounded upbeat on second-quarter conference calls, Southwest CEO Gary Kelly was cautious: "I am concerned about the U.S. economy. I have concerns about fuel prices."
Given their volatile history, airline stocks scare many long-term holders. But they're frequently trading vehicles for hedge funds and others seeking high-octane plays on energy prices and the economy.
Institutions often avoid stocks with negative profit revisions. United Continental now is expected to earn $3.30 a share in 2011, down from a forecast around $5 at the end of 2010. AMR is expected to lose almost $4 a share this year, versus a profit projection of 23 cents at year-end 2010.
Barclays' analyst Chase is encouraged that airlines are doing a better job of aligning supply and demand, with the major carriers reducing domestic capacity as they retire older, less fuel-efficient planes.
Comments Deutsche Bank's Linenberg: "The industry is reaping the benefits of a significant restructuring and greater concentration. For the first time in history, it is deleveraging its balance sheet." It's also consolidating. Pairings in recent years include Delta and Northwest, Continental and United Airlines, and USAir and America West.
United, Delta, Northwest and USAir, used bankruptcy to restructure labor agreements, aircraft-leasing obligations and pension plans,to become competitive with low-cost carriers like Southwest and JetBlue.
While debt levels remain high, several airlines are reducing leverage. Delta has cut net debt by $3.2 billion, to $13.8 billion, in recent years. In the second quarter alone, it slashed its obligations by $700 million, and its goal is to trim debt to $10 billion.
One big positive: Airlines have a lot of cash. At the end of the second quarter, United Continental had more than $8 billion; AMR, $5.2 billion; and Delta, $3.8 billion. JPMorgan analyst Jamie Baker noted recently that airlines' enterprise values (stock-market value, plus net debt) had returned to 2009 lows. Equity values may be higher, but debt levels are down. Baker wrote that while he was "frightened" for the industry in 2009, during the financial crisis, he's "merely concerned" now, arguing that the "risk-reward appears highly attractive" for investors willing to take a mildly optimistic industry view. The combined market value of the seven major carriers is only $25 billion, while their combined enterprise value exceeds $80 billion.
