Investors Snap Up Airlines, But Have Metrics Improved?

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On Tuesday,Delta Air Lines ( DAL ) rejoined the closely watched Standard & Poor's 500 stock index after an eight-year hiatus.

The milestone in the airline's recovery came earlier than expected, after index member BMC Software was removed from the list when it was bought by private equity firm Bain Capital.

Delta, the world's largest airline by number of passengers carried, was dropped from the index in 2005, shortly before it filed for Chapter 11 bankruptcy protection.

Delta shares jumped 9.4% on Tuesday to 21.76, just below its post-bankruptcy high of 22.05 set on Aug. 1, lifting the sector. The 18-company IBD Transportation-Airline group climbed 3.3% for the day in double its usual trading volume.

That helped drive the AmEx Airline Index ahead 4.8% for the week through Thursday. IBD's 17 stock Transportation-Airlines group rose 4.9%, better than double the S&P 500's gain. The industry has been hungry for good news after being buffeted this year by rising oil and jet fuel prices, and weak revenue gains as consumers continue to rein in spending. The group still ranks a weak No. 122 among 197 industries tracked by IBD.

Recession's Effects Linger

Other factors limiting the industry's altitude include lingering recession in Europe and worries about possible travel disruption and higher fuel prices if the U.S. gets involved in the Syrian civil war.

Those issues have helped pull the airlines group, with a combined market value of $481 billion, down among IBD's industry groups from a healthy No. 19 rank at the start of June. Despite current turbulence, it's clear the industry's health has improved since the recession ended in June 2009.

Sterne Agee analyst Peter Arment said that in the last 30 years there have only been three years when air passenger traffic count fell: recession year 1991, after 9/11 in 2001 and in 2009, at the end of the recession.

Global air traffic fell 3.4% in 2009 to 767 million passengers, excluding foreign short-hop flights, according to Department of Transportation figures.

Despite recent woes, "air traffic has been very resistant to economic pullbacks," Arment told IBD. "It's not only business travel seeing a comeback, but consumer travel as well."

Traffic rose 2.7% to 787.5 million in 2010, but growth slowed to 1.9% in 2011 and rose just 1.4% in 2012, when 813.1 million flew.

This year is still on the chopping block, with the global passenger count roughly flat through May. In the past week, United reported its revenue per passenger mile dropped 1.3% in the first eight months of the year.Southwest Airlines ( LUV ) reported its RPM rose 0.8% in the same period.

In overview, U.S.-based carriers are generally divided into three groups: Global carriers such as Delta and archrivalUnited Continental ( UAL ) fly national and international flights. Low-cost operators such asSpirit Airlines ( SAVE ),Alaska Air ( ALK ) and Panama'sCopa Holdings (CPA) run regional routes. And short-hop carriers such asRepublic Airways (RJET) provide services to American, Delta and other large carriers.

The International Air Transport Association, a trade group, said in its July-August report that, worldwide, airline stocks fell 6% in August, underperforming the market as crude oil and jet fuel prices rose.

"But airline share prices are still up on a year-ago (basis) in the U.S. and Europe, reflecting better financial performance," the IATA said.

Low-cost carriers are benefiting from consumer frugality, says Robert Mann, head of airline industry research firm R.W. Mann & Co.

"Ultra-low-(cost) carriers are getting a lot of attention. That's because they're bringing home superior economic returns versus the cost of capital," Mann said.

Spirit Airlines, for example, has reported double-digit profit gains in five of the last six quarters. Its stock boasts a 93 IBD Composite Rating, meaning it's outperformed 93% of all stocks on key metrics such as sales and earnings growth.

"We're also seeing some strong regional performance from Alaska Air," Mann said. "The last three years they've produced economic margins well in excess of their capital. It looks like they will continue to do so."

Southwest Airlines is in a category of its own. It started as a low-cost carrier in 1967 and grew to national prominence. In May 2011 it bought AirTran Airways, which as of July served 47 destinations in the U.S, Mexico and the Caribbean. Southwest is expected to move into the global airline ranks when the integration of AirTran is completed next year.

"They are the 1,000-pound gorilla" in the domestic market and aim to muscle into the global market, Mann said.

Honey, I Shrunk The Industry

The industry continues to consolidate at a rapid rate.

On Feb. 14,US Airways (LCC) and bankrupt American Airlines, owned by AMR Corp., said they planned to merge and create a mega-airline, the largest in the world.

The proposed merger has managed to rile up the airline industry, federal regulators and Wall Street.

Last month the Department of Justice sued to block the merger, causing US Airways to drop 13% and AMR to drop 45% in massive trading volume on Aug. 13.

The government and some rival airlines say the pairing could give the merged company an unfair competitive advantage. They claim it would funnel 85% of U.S. fliers into the seats of just four big airlines: Delta, United Continental, Southwest and a merged US Air/American.

US Airways and American, which hopes to emerge from bankruptcy via the merger, say they need to merge to stay competitive with giants like Delta and United, the world's two largest airlines, with annual revenue of about $37 billion apiece.

A federal trial judge has slated the Justice Department's suit to go to trial on Nov. 25. A decision could come as early as the end of the year.

The brouhaha over their merger attempt comes after a decade-long wave of combinations trimmed the number of U.S. airlines in recent years.

Delta, which flew 165 million passengers in 2012, is the product of mergers including a marriage to Northwest Airlines in 2008. The deal vaulted the combined carrier into the leadership spot along with United.

United, which logged 140 million passengers last year, has also been on the M&A trail. Most recently, it merged with Continental Airlines in 2011.

Both combinations have struggled. Delta's profit growth turned around in the first quarter of this year after declines in five of the seven prior quarters. But its revenue growth over the last three quarters slowed from 2% to 1% to nil last quarter.

Outlook: Bluer Skies Ahead

As global economies continue to struggle, airlines maintain a cautious stance on spending.

"At the same time, they are trying to upgrade fleets to have more fuel efficiency because of higher fuel prices, which is good for aircraft makersBoeing (BA) and (European aerospace consortium) EADS," Sterne Agee's Arment said.

The upgrades are expected to cut costs dramatically.

Like the airlines, Mann is cautiously optimistic.

"Airlines' earnings have been pretty strong in general, and ticket pricing is stable. There have been no recent price increases, except to fees," and ticket price stability could draw more travelers, Mann said.

He notes that the new Boeing 787 Dreamliner wide-body is 20% more fuel efficient than the 767 it replaces. Despite its battery problem earlier this year, it has a sophisticated electronics system and new features designed to make long-distance travel more enjoyable. It and the new Airbus A380 made by rival EADS could draw in more fliers

"A growth area for large carriers is international routes," Mann said.

United Continental, the only U.S. carrier so far with a fleet of Dreamliners, has laid out a map to open up new nonstop global routes.

In June 2014, for example, United is set to begin the first-ever nonstop flights from the U.S. to Chengdu, China, the capital of Sichuan province and one of the most important economic hubs in western China.

And United this winter plans to begin the first Houston to Lagos, Nigeria, flights.

"Oilfield crews are going back and forth all the time," Mann said.

As the economy recovers and new nonstop flights whisk travelers to remote corners of the world, the industry could see a long growth wave, he said.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas

Referenced Stocks: ALK , DAL , LUV , SAVE , UAL

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