Nearly Bankrupt Airlines: A Good Short

Earlier this year, when the swine flu first hit, Joe Biden advised staying away from crowded public places as much as possible. He was later asked to correct himself because others realized his words would hurt businesses.

Those words are about to come home to roost. The fall, typically flu season, is almost upon us. Several biotech companies have developed a swine flu vaccine, but it probably won't be ready in time in sufficient quantities to immunize the huge number of people who will want and need it early this fall.

This virtually guarantees a “real pandemic” of swine flu. There will be enough vaccine for medical personnel, but not enough for everyone else. There will likely not be enough hospital facilities or probably medical professionals for all who need them. When I now think of a long plane flight in a real pandemic swine flu season, it is with dread!

I am sure I am not alone. I am also sure many other industries will be hurt: restaurants, cruise lines, amusement parks, shopping malls (Amazon (AMZN) may even prosper for this reason), etc.

Still you can always walk away from sickness in most of those places. On a plane flight, especially a long one, you are stuck. If the person or persons next to you are ill, your chances of catching their flu on a 5-6 hour or more plane flight are excellent. I wish it were not so.

Still if this were the only reason for picking on the airlines, I might refrain. The truth is that airlines are on extremely shaky ground without the swine flu to hurt them further. They have already been hurt by the economy this year and last. They were extremely hurt by the high fuel costs of 2008. They are still reeling, waiting for the knockout punch. The swine flu may provide that. At the very least it will likely score a knock down. Many airlines may need a government bailout before the recession and high unemployment are done. The following table contains relevant fundamental information about some of the carriers. I may show bias toward long trip carriers. Those trips scare me the most. I am probably not alone in this.

Let’s first take a look at the chart of the airline ETF FAA to see if we are going to be shorting it at an appropriate time. The chart is below (click images to enlarge):

FAA is overbought. Its price, as I write, is $23.54. It is about 20% above its 50-day sma. It is up by its top Bollinger Band. The Williams %R reading is roughly 0 (very overbought). The Money Flow chart looks like it is topping out. It is likely headed downward soon. This makes me think that the sector will cooperate in a shorting situation. The volume as FAA has gone up recently has been low. Everything seems to be well set up for a near term turn downward.

The following table contains some of the relevant fundamental data from some individual airlines. The data looks ugly to me.

Stock	Price	2009 PE	2010 PE	P/B	P/CF	Quick Ratio	Debt to Capital	% above 50-day sma	1 yr. Price Target
UAUA	$6.04	--	--	--	--	0.64	150.72%	38.41%	$14.88
CAL	$12.39	--	13.6	6.28	--	0.84	96.18%	20.42%	$18.46
DAL	$7.41	--	11.4	5.78	--	0.72	94.47%	17.00%	$12.20
ALGT	$42.29	10.4	10.1	--	8.25	n/a	n/a	3.83%	$57.50
LUV	$9.11	--	25.3	1.32	17.26	0.94	40.50%	22.17%	$9.42
AMR	$5.94	--	--	--	23.67	0.56	141.52%	24.07%	$12.28
SKYW	$13.74	13.3	7.8	0.59	2.40	2.71	58.35%	18.56%	$12.75
HA	$6.86	4.7	6.0	--	3.61	n/a	n/a	12.10%	$11.17
JBLU	$5.25	23.9	11.9	1.06	7.81	1.12	69.66%	12.95%	$7.63
RYAAY	$28.72	16.3	12.5	2.34	20.45	1.96	51.25%	0.91%	$40.40
ALK	$23.18	11.0	8.3	1.17	13.72	1.19	70.82%	12.47%	$30.88

This data is from Yahoo Finance, TD Ameritrade, and ShortSqueeze.com.

The “—“ data points are for negative underlying data situations, where a valid value cannot be calculated. In the cases of the PEs, this was definitely true. For other categories, TD Ameritrade did not have valid values for these items.

On book value alone, I would exclude LUV, SKYW, JBLU, RYAAY, and ALK. I would exclude ALGT and HA from shorting based on their 2009 PEs. This only leaves UAUA, CAL, DAL, and AMR. All four of these airlines have Debt to Capital ratios of more than 90%. All four are far above their 50-day smas. All four are estimated to lose money in 2009. Two of the four (UAUA and AMR) are estimated to lose money in 2010.

Still the earnings estimates for both CAL and DAL for 2010 have been trending strongly downward. CAL’s 2010 EPS estimate has moved from $3.25 90 days ago to $.91 today. DAL’s 2010 EPS estimate has moved from $2.00 90 days ago to $.65 today. Given the strength of the downtrend in earnings estimates for each of these companies, it is likely both will lose money in 2010. Aren’t you amazed these stocks have been going up so strongly?

Of all of these I like CAL as the best short. It has the highest stock price (i.e. it has the farthest to fall). It has the most room for disappointment in 2010 earnings, since it still has a positive estimate. It is extremely likely to have its current estimate for 2010 lowered.

As the earnings estimates of these four stocks will likely continue to be re-adjusted to the downside, the market should sell them off. The likely severe worsening of the swine flu pandemic in the fall (flu season for the Northern Hemisphere) should accelerate this re-adjustment downward. If oil prices rise appreciably in 2009 and 2010, that should also accelerate the downward adjustments to earnings estimates.

All four of these companies have Quick Ratios under 1.0 (i.e. they will have trouble paying their bills). All four of them are heavily in debt. All four of them are highly overbought at the current time. This makes them all good short candidates.

The overall equities markets are also overbought. They should retrace. These four stocks should outperform the market to the downside. I have included the chart for each below.

CAL:

UAUA:

DAL:

AMR:

These stocks should all be good shorts, although I like CAL as a short best. They all are significantly above their 50-day smas. They are all near their top Bollinger Band. They are all overbought based on their Williams %R graphs. Plus CAL, DAL, and AMR look like they might imminently find resistance to the upside from their descending 200-day sma.

The only worrisome item is that money has clearly been flowing into all of these stocks. Of course, you would expect that if they have been going up, which they have. CAL has risen from a recent low of $8.07 on June 23 to Friday’s close of $12.39. That’s a 53.5% gain in about 6 weeks. This company has been losing money. It has seen it earnings estimates cut horrifically during the last 90 days. The trend in earnings estimate revisions is still downward. This stock is ripe for a pullback. One should be able to make money on this pullback.

There is always the worry that the stock will continue upward. However, the overall market is due to pull back. That is likely to begin either next week or the following week. The market pullback should give extra momentum to a downside movement from these airline stocks, which seems almost inevitable.

Pick an entry point in one or more of the 4 stocks next week. Set a close stop. Let yourself be stopped out if it continues going up. Get back in on the downside with another close stop, when you think you have picked another opportune moment. For 3 of the 4 stocks, the current price may very well be the opportune moment. They may find resistance in their still descending 200-day smas.

Please investigate these stocks on your own. This data is just meant as a starting point. Good luck.

Disclosure: I have a short position in CAL.

Comments

[AirBoss:]

This opinion assumes they will all go quietly, without any attempt to raise capital. To paraphrase Mark Twain, "Reports of the airline industry's death is greatly exaggerated."

Aug 09 08:04 AM

[skwestorange:]

It appears that the economy as a whole is clearly on the mend. That should increase high margin business travel. Fuel prices are behaving well again contributing to increased margin. Iraq withdrawal is ongoing and that should also contribute to increased Military charter. All in all the fundamentals are improving and that is clearly reflected in the higher stock prices for the transport stocks. Perhaps if these stocks gain another 10-15% then shorting may be appropriate.

Aug 09 10:43 AM

[hammerup:]

Good article. The book The Long Emergency by James Kunstler says that in the long run, airlines are toast, because at $100+ per barrel oil, it's just going to be too expensive to push planes through the air at 500+MPH. Still, the morons that are pouring money into the stock market day after day, do so without regard to industry or sector. Well actually, they seem to especially love pouring it into beaten down sectors like banks, insurance companies, casinos and airlines more than the rest. Why? they can get a bigger bank for their buck by squeezing the shorts. I would agree that when the larger market breaks back down (if ever) airlines would be right at the top of my list to short. In the meantime, I'll just watch and salivate a little. One other thing to consider is that for sure, if the airlines reach the point where they might die off, the government in its present form will be rushing in to bail them out. So don't stay too long at the shorting party. 20-30 percent profit will do just nicely..

Aug 09 10:49 AM

[David White:]

skwestorange: I guess you missed those debt figures and the quick ratios on the airlines. Take a better look at them. The airlines I mentioned as good shorts are likely to need government help soon. They may be able to raise capital, but it will be a tough sell.

The oil prices (fuel prices) have been going up. GS has a prediction out that they will hit $85 by the end of the year. The public is still mentally attached to airline prices based on $20-$50/barrel oil. The necessarily higher prices by themselves will hurt airlines.

The downsizing during the recession will hurt airlines.

The British Health Minister a few weeks ago predicted the UK would have as many as 100,000 new cases of Swine Flu "per day" by the end of August 2009. If this number is only 10,000 new cases per day, this would have a huge negative impact on the airline industry. The US, Canada, and others are likely to face similar Swine Flu problems. I have included a note from W.H.O. below about why some people may be scared of Swine Flu.

WHO: "31 JULY 2009 | GENEVA -- Research conducted in the USA and published 29 July in The Lancet [1] has drawn attention to an increased risk of severe or fatal illness in pregnant women when infected with the H1N1 pandemic virus.

Several other countries experiencing widespread transmission of the pandemic virus have similarly reported an increased risk in pregnant women, particularly during the second and third trimesters of pregnancy. An increased risk of fetal death or spontaneous abortions in infected women has also been reported."

Aug 09 03:00 PM

[David White:]

Dr. Roubini now forecasts below par growth for the US of about 1% for both 2010 and 2011. If he is right, this likely means there will be no upturn for airlines anytime in the near future. It also means continued high unemployment for a long time, which means trouble for bookings. The airlines I selected for shorting will all lose money in 2009. If Dr. Roubini is correct, they will likely all lose money in 2010 and 2011, especially given the forecast for oil prices to rise.

Supporting Dr. Roubini's thesis, Paul Krugman, a Nobel Laureate economist, is now saying that the world needs a second stimulus to avoid a lost decade (such as Japan's of the 1990's).

Notably both the US Congress and President Obama have said they have no plans for a further stimulus at this time. Obama insists that the current stimulus will start to be felt more as time goes on.

Aug 10 03:46 AM

[David White:]

RothmanResearch.com issued an advisory today that they are tracking CAL (expecting an ongoing correction).

Aug 10 11:22 AM

[David White:]

Airlines got a little more bad news today when Chevy announced its mpg figure of 230mpg for the Volt. Chevy called this figure conservative. With this kind of gas mileage, a few more people will elect to drive to "closer" airline destinations.

Aug 11 09:03 AM

[hammerup:]

I shorted 500 shares of CAL this morning. Just as a hedge against my long positions in other sectors. Chevy Volt rating is of course only good if you drive 40 miles or less per day. After that, it's just a gas engined car.
I was thinking this morning about Boeing, and that something they could think about is coming out with a turboprop model of relatively low speed, say 300 MPH, but high fuel efficiency. This might be doable, and would save them and the airlines from imminent death. For example, I would buy a $300 R/T ticket from MSP to LAS on the 300 MPH plane, versus an $800 ticket on the 500 MPH plane, any day..


On Aug 11 09:03 AM David White wrote:

> Airlines got a little more bad news today when Chevy announced its
> mpg figure of 230mpg for the Volt. Chevy called this figure conservative.
> With this kind of gas mileage, a few more people will elect to drive
> to "closer" airline destinations.

Aug 12 12:09 PM

[boisterousbob:]

Lol not only is the 230mpg for the Chevy Volt only good for 40 miles, but this value doesn't tell you how much your electricity bill will go up when you plug it in each night either....

With typical electricity prices you will be paying $2.64 to charge your car up and go 40 miles. This will buy about a gallon of gas which will drive one of todays fuel efficient cars 30-40 miles anyway.

The Volt is interesting, but it ain't necessarily gonna cut your fuel bills much....

Aug 15 09:21 PM

[David White:]

boisterousbob: The 230mpg is based on gasoline equivalents. This means the cost (energy expenditure) of charging the Volt is already factored into the 230mpg figure. For instance, the Nissan Leaf, which is totally electric, gets 367mpg. It has only a 100 mile range though.

Aug 18 01:27 AM

[David White:]

Hammerup: Unfortunately most people would not accept a slower plane, except on very short trips. For instance, from the Bay Area to Tahoe, they often use turbo prop planes.

I suggested to Boeing management at one point that they consider building natural gas powered planes, as this seems to be much cheaper than jet fuel. Also with the latest natural gas discoveries in the US, the US has a relatively plentiful supply of natural gas (i.e. using it would not add to the trade deficit). Even if the US ended up importing some natural gas, it would still be cheaper by far than oil. Plus there are a limited number of airports. The infrastructure for refuelling with natural gas would not be a huge problem.

My suggestion about natural gas powered airplanes was not taken very seriously.

Aug 18 01:36 AM

[David White:]

In the news today, the number of US airline departures declined. Airline stocks were down on the news. Swine flu hasn't even hit in force yet.
In reference to Swine Flu, only 45M swine flu vaccine doses will be ready for the US in October. They had expected 120M to be ready. This is bad news for the airlines.

Aug 18 01:42 AM

[David White:]

Airlines went down for a while. Now they are going back up on the back of the overall rise in the equities markets. Also airlines are adding wireless service throughout flights. This is very popular among the business travellers.

All of this up movement is good for the short sellers. I was out of my CAL position early in options expiration week. I now looking to get back in. The swine flu should do a lot of damage to the airline industry. As September (generally the worst market month) gets underway, the swine flu should too. Kids will be going back to school. When they do, they will spread the disease. There may be a lag before airlines negative numbers begin to show up, but show up they will. This should be a good short opportunity, especially if thsi current rally can drive the prices higher near term.

Aug 25 11:58 AM

[David White:]

I should have mentioned that I currently believe that crude oil is in a retracement pattern from its recent approx. $75 high. When it gets to a fairly major support point, I will then start thinking of shorting airlines again. I will also be lookign at the overall markets and the swine flu news. If either or both are really bad, I may consider shorting airlines before oil has reached a major support point. I also have a recent article about shorting oil. This delineates thesupport points, etc.

seekingalpha.com/artic...

Aug 25 09:32 PM