Since the middle of July, the business headlines have been
relentlessly scary as governments, corporations and individuals
scramble to stay afloat in a weak global
. Yet for airline industry executives, each day brings more good
news. Oil prices are falling and look set to fall even more in
Crude oil was above $110 per barrel in late April, but has since
fallen to about $84. Now that the crisis in Libya appears to be
resolved, it should start boosting output back up to prior levels,
right at a time when global oil demand may be trimmed a bit in the
face of an economic slowdown. At this point, a move toward $70 oil
may be in the cards as these factors play out.
Whether we're talking about a $25 drop in crude oil now, or an
eventual $40 (total) drop from that late April peak, airline
executives are overjoyed. Jet fuel (which is further refined and a
bit more expensive than underlying crude) is the single-biggest
cost for an airline outside of labor. When oil was surging, many
carriers such as
of American Airlines, had to brace investors for rising losses
while others such as
United Continental (NYSE:
U.S. Airways (NYSE:
had to make-do with ever-smaller
Now, get ready for analysts to start to boost their profit
forecasts. Once they do, investors are likely to take note of this
industry's rock-bottom valuations. For example,
which remains my favorite airline play
, trades for about four times projected 2012 profits.
Of course, many question the wisdom of owning airline stocks in a
slow economy. After all, aren't these the same companies that have
flirted with bankruptcy many times before? Well, with the exception
of AMR, all of the major carriers have learned to run their
businesses in a much different manner, holding down labor costs,
route capacity and their order books.
And their balance sheets are now truly healthy.
, for example, has access to more than $5.5 billion in cash and
credit lines. Crucially, we're not seeing price wars that have
historically sapped airline profits, either. This is the result of
early decisions to pull back capacity on unprofitable routes.
Simply put, the pullback in oil means carriers can operate
profitably even as unemployment hovers around 9%.
It's not just the airline stocks that should look more appealing,
but also the ancillary businesses that serve them. Here are two
airline-related names that should flourish as investors realize the
broader industry isn't about to enter into a deep swoon.
BE Aerospace (Nasdaq:
This company helps airlines build out the interiors of new planes
and upgrade the interiors of older planes. It's a "rain-or-shine"
that should do well whether carriers upgrade their fleets or extend
the useful life of existing planes. For example, in the economic
downturn of 2009, when carriers put a freeze on new plane
deliveries, BE Aerospace saw sales drop just 8% to $1.9 billion
because the refurbishment end of the business fared well.
Free cash flow
still exceeded $50 million, the third-best performance in company
history (behind 2008 and 2010).
Even though the company's dual-pronged exposure reduces
still trade well below the historical average of 18 times
, and can currently be had for less than 12 times projected 2012
Looking past the near-term economic challenges, this is a business
model built for solid growth over the long haul. BE Aerospace has
been providing an expanded level of services and products to
airline carriers in recent years, moving beyond the core focus of
seats into lighting, HVAC systems, cooking systems and other cabin
amenities. This has fueled 20% compound annual growth during the
past five years.
The broadened skill set should really pay off because carriers are
expected to eventually make a big push to upgrade their fleets to
much more fuel-efficient widebody planes that have recently been
and Airbus (such as the 787 Dreamliner and the A380, respectively).
Merrill Lynch analysts note these planes can carry five times more
"shipset content" than smaller planes, as they "usually have more
luxurious premier/first class furnishings... and generate higher
demand for seating and food and beverage equipment." As an example,
every Airbus A380 being outfitted for Emirates Airlines carries an
estimated $5 million worth of BE Aerospace gear. With shares near a
, this is a great entry point for this long-term winner.
This is the "little engine that could," that is, until it couldn't.
Shares of this aircraft leasing firm were steadily climbing toward
of $17.90 a share, but the recent market weakness has wiped out all
of its earlier 2011 gains.
With shares now trading for just 60% of book value, it's time for
investors to jump back in.
Aircastle buys planes directly from manufacturers and then leases
them to airlines and other customers. Aircastle assumes the risk of
ownership, but the profit spreads can be immense when times are
good. Judging by Aircastle's
cash flow statement
, times are quite good: Free cash flow (
) has steadily risen from $60 million in 2007 to $343 million in
The key question is whether airline carriers will hit a deep slump
and Aircastle will need to take back many of its planes, running
into its own financial trouble. This was a fair question when the
airlines were reckless with their balance sheets. But as they've
taken a much more mature approach to expansion and financing, they
simply aren't the "bankruptcies waiting to happen" that they once
were. So Aircastle's deep discount to book value seems to
anticipate a possible dire future that is very unlikely to ever
Risks to consider:
In a nutshell, I think these companies are still set to make
money if the event of a mild
, thanks to lower oil prices. But a really deep recession would
deeply cut ai travel, also causing airfares to plunge and losses
instead of profits. Since these companies still have debt,
investors would shun them if they were in money-losing mode, for
fears that the bankruptcy risk would be back on.
Action to Take -->
The pullback in oil prices is more of a positive for these stocks
than the global economic weakness is a negative. As a result, look
for analysts to maintain or even boost their profit forecasts for
the industry when quarterly results are released in late October.
But you could be early to the game by pouncing on any of these
three stocks beforehand and enjoy what is likely some major
-- David Sterman
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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