During the past few years, airlines staged a remarkable
comeback. The major legacy carriers such as
American Airlines and
United took a lot of planes out of service, cut major cost-saving
labor agreements, and benefited from sharply lower fuel prices.
Large losses became large profits, helping the
AMEX Airline Index (AMEX:
to rise from around $12 in March 2009 to $40 in mid-June.
Yet in recent weeks, the
has headed south, falling for eight straight sessions before a
on Wednesday. The sector saw some life when Delta 's CEO Richard
Anderson spoke bullishly earlier in the day at his company's annual
meeting. "The recession was a 'terrible cycle' that has wreaked
havoc on balance sheets and stocks," he said, "but we are now
moving into an up cycle."
That's certainly the case, by any measure. Ticket prices are
higher, leading to +20% year-over-year gains in passenger revenue
per average seat mile (known by the unwieldy industry moniker
PRASM), fuel costs remain manageable, and the European volcano
scare has abated, boosting air traffic on the Continent to
Firming prices and low costs add up to money in the bank:
Continental, Delta , AMR and UAL should see profits rise sharply
this year, posting their best gains in years. Continental for
example, has a decent shot of earning even more than the $3.74 a
share bagged in 2007, a high point for the last decade.
But clouds loom on the horizon. For starters, management talked
labor into major concessions a few years ago, and many of those
contracts are coming up for re-negotiation. You can bet that labor
will be a lot less cooperative this time around.
In addition, even as European air travel has posted a solid
rebound, further economic weakness on the Continent could spell
trouble. Remember that planes have the same expenses whether they
are half-full or completely full. As a rule of thumb, a plane needs
to be roughly two-thirds filled to be operating at break-even.
Right now, the load factor (the percentage of seats filled) is
inching toward 80%. It helps that there are roughly 15% fewer
planes flying than in 2008. The major carriers will begin releasing
their latest load factors and PRASMs in the coming days (starting
with Continental after the bell on Thursday), and share prices may
move quickly up or down on that data.
Finally, the industry is always one step away from a profit-sapping
spike in oil prices or a terrorism-related slump in air travel.
Neither of those factors is of concern at the moment, but they can
arrive without warning.
Loss from peak
Market Cap. ($m)
As the accompanying table shows, these stocks are dirt cheap, with
several of them trading for less than five times projected 2011
price-to-earnings ratio (P/E)
multiples are based on consensus estimates. And analysts are
assuming very strong profit growth in 2011. But should they? After
all, labor costs are set to rise, and it may be awhile before the
global economy is truly healthy. So further volume and pricing
gains may be hard to achieve.
Action to Take --->
It increasingly looks as if 2011 profit estimates will need to come
down. So the industry
ratios are probably not as low as they appear in our table. But the
kind of earnings power that analysts expect to see in 2011 could
still well happen in 2012 or 2013. So shares are indeed quite cheap
if you have that kind of time horizon.
It's worth noting that
Southwest Air (NYSE:
is not as exposed to rising labor costs, as it inked more recent
labor contracts. So analysts' estimates for LUV are not likely to
come under the same pressure. In addition, this is the first time
in its history that
has traded for less than ten times projected earnings. JetBlue also
has a better labor cost profile than the big carriers. These two
low-cost carriers are also less exposed to the possibly turbulent
European air market, making them the safer plays, even if they
sport higher P/E ratios than the larger legacy carriers.
-- David Sterman
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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