When a stock or sector has great upward momentum, my natural tendency is to look for a reason to sell it. Some may say this is a reflection of an unattractive pessimism ingrained in my character or some deep seated resentment of success, but I prefer to think of it as behavior learned from nearly twenty years in dealing rooms. For evidence I would cite the fact that the opposite is also true; when a stock has been under pressure, I look for reasons to buy it.
It is not that I am contrarian for the sake of it, it’s just that trading and investing are all about balancing risk and reward. Obviously, if something has been on a sustained run up there is less upside left and more risk to the downside. The more exaggerated the move, the more that risk/reward equation shifts.
One would think, then, that airline stocks, which as a sector have been on a tear over the last few years, would be something for me to avoid. Sometimes, however, such a move is based on fundamental shifts in the economy and/or in the prevalent business model within an industry. In that case even a sharp move up can easily be sustained, and that is the case with US airline stocks.
There were very few sectors that got hit harder in the recession of 2008/9 than airlines, and understandably so. Flying, whether for business or pleasure was a logical starting point for struggling companies and individuals looking to cut outgoings. Some were even predicting a permanent end to business travel. I mean, why fly for a meeting when you can meet virtually? Now that the economic conditions have begun to improve, however, business travel is back. The Global Business Travel Association has been racing to upgrade their forecasts for 2014, and now expects a 7.1% increase for the year to over $293 Billion.
We remain, it seems, social animals and reports of the death of business travel seem somewhat premature. People still fly and the major carriers’ decision to charge fees for everything other than a basic ticket may be grumbled about but flyers are becoming used to it and it has increased margins in a low return business. Airline revenue looks set to continue to grow.
More importantly, though, particularly for the big, traditional airlines, costs have been under control. Some may see it as a dirty trick to back out of pension commitments and change terms of employment, but from a purely business perspective the prior situation was untenable, and reduced staffing costs are probably here to stay. The other major cost for airlines, fuel, is less predictable, but with oil prices in general looking capped by the increased supply from shale that cost too is likely to remain manageable.
So, as ever, if the conditions look good for US airlines in general, the question for us market types remains, how best to profit? The discount airlines such as Southwest (LUV) and JetBlue (JBLU) have been some of the major beneficiaries of the recovery in travel, and will continue to do well.
One would think that, looking at the above charts, both LUV and JBLU were at least at full value if not a little overbought, but at forward P/Es of 14.7 and 10.7 respectively, they don’t look too expensive on a fundamental basis.
The traditional large US carriers, however, may be even better placed to continue to prosper. They were hit harder by the recession and have struggled to adapt to a lower cost, leaner business model, but the worst of that transition is behind them. Consolidation and bankruptcies have left the new American Airlines (AAL) and Delta (DAL) in the previously unthinkable position of actually making money.
Those improved fundamentals have certainly been reflected in the stock prices of both AAL and DAL, as you can see. Once again, though, if you look at the fundamental value measure, P/E, both AAL at below 7 and DAL at just over 11 look anything but overpriced.
As I said, it goes against the grain for me to look at charts with a sharp upward slope and see value. In this case, however, the past performance of the stocks has nothing to do with their attractiveness right now. Even if we assume that the analysts’ forecasts on which those forward P/E numbers are based are optimistic, trailing P/Es around 20 suggest that, even without the expected level of growth neither AAL nor DAL have a big drop coming in the near future.
Regardless of the last year or so, then, there would seem to be limited downside risk and a decent chance of continued upside movement. If costs remain stable and revenues continue to increase, then the stocks look cheap here and I will happily forego my tendency to punish a stock for success.