Investors have had to rethink everything they know about airline
stocks during the past few years. The considerable pain caused by
the economic downturn of 2008 forced the airlines to make drastic
moves. They aggressively cut labor costs, found new ways to charge
for items that were previously free (such as checked baggage) and
showed remarkable discipline when it came to paring any airline
routes that were unprofitable.
Perhaps the poster child for this industry's renaissance can be
seen in the operations of
Delta Airlines (NYSE:
DAL
)
, which I projected
would double in price
when I profiled the stock nearly a year ago. (It's made a nice run,
but is still well short of my predicted 100% gain.)
In recent weeks, I've been thinking about airline stocks a lot.
Not only are these companies run so much more efficiently, but
they've recently been the beneficiary of a solid multimonth drop in
fuel prices -- which is their largest single expense. Even though
oil prices have recently rebounded somewhat, due to tensions with
Iran, I still see oil prices falling to fresh multiyear lows in
coming months
as I noted here
.
Yet with every investment thesis, you always need to hear
opposing viewpoints. Goldman Sachs just released a report that
expresses ample concerns about these airline stocks. I disagree
with some of their basic tenets, but they are worth noting
anyway.
Goldman's biggest concern involves the state of the global
economy
. The firm is anticipating a drop-off in global air travel in
coming quarters, which will affect profits of the major carriers.
That could prove especially tough for
Delta
Airlines and
United Continental (NYSE:
UAL
)
, each of which are now rated a "sell" by Goldman.
JetBlue (Nasdaq:
JBLU
)
and
Southwest (NYSE:
LUV
)
are rated "neutral" simply because they don't have as much foreign
exposure.
Here's how Goldman's
earnings
view contrasts with the consensus forecasts.
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You'll notice an especially big gap between Goldman's 2014
profit
outlook and the rest of the pack. While most analysts expect
industry profits to keep rising into 2014, Goldman thinks profits
will shrink for most of the airlines (except Southwest).
Why the pullback? Because the Goldman analysts say airline
carriers will revert to their old bad habits of adding a lot of new
capacity in 2013, which will create price wars by 2014. Yet such a
view flies in the face of what has actually been happening the past
few years. In fact, once AMR, the
parent company
of American Airlines, emerges from bankruptcy -- likely though a
sale to
U.S. Airways (NYSE:
LCC
)
-- analysts expect American Airlines' global roster of flights to
be notably reduced, aiding the supply/demand balance of available
seats for all industry players.
Yet it is fuel price assumptions where Goldman simply seems off
the mark. Goldman sees jet fuel prices rising 12% sequentially in
the third quarter to about $3.12 a gallon. The firm says oil prices
will continue rising as they have in recent weeks. Yet it's worth
noting that the current
spot market
for jet fuel is $2.78 a gallon, even with Iranian tensions already
in place.
In subsequent periods, Goldman's energy analysts anticipate
Brent Crude oil prices (the
benchmark
for Europe) to rise to $118 a barrel from a current $100. Yet these
analysts can't have it both ways. If the global economy is not
robust in coming quarters, then there is a very good chance that
oil prices weaken from here -- not strengthen.
That's the view held by Deutsche Bank, which just boosted
expected industry profits in the June quarter by $400 million to $2
billion, thanks to lower oil price assumptions. In tandem, Deutsche
Bank just raised earnings forecasts for all of the airlines it
covers for both 2012 and 2013.
And it's not just oil prices that may represent savings,
according to Deutsche Bank. Airline carriers have refinanced debt
at lower interest rates, which is lowering quarterly interest
expense. Moreover their total debt loads continue to shrink, which
will lower interest expense even further in coming
quarters.
Deutsche Bank's favorite airline stocks: Delta (with a $16
price target
), United Continental ($31) and U.S. Airways ($20). That's roughly
35-50% upside for each name. In contrast, Goldman's target prices
on Delta and United are roughly 10% below the current
prices.
Risks to Consider:
The U.S. economy is indeed slowing, and even though that hasn't
affected demand for air travel yet, it's too soon to conclude that
demand won't weaken. The question is by how much. My view: the
industry already operates as if we are in a
recession
and are built to be profitable at a range of revenue levels.
Action to Take -->
The analysts at Goldman are likely correct in anticipating a
slowdown in air travel. But their expense assumptions appear all
wrong. These airline carriers will likely see the lower revenue and
falling oil prices offset each other. These stocks, which took
solid hits in Thursday trading, thanks to Goldman's
call
, will likely start rallying again the minute oil prices start to
move back to their recent lows.
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.