Merger Mania Grips the Airlines

Includes: AAL, UAL, UAUA
by: Dan Carty
I have been bullish on the airlines since early September (though as I have mentioned, I should have been bullish from a much earlier point). I started with a purchase of US Airways (LCC), American Airlines (AMR) and Continental Airlines (NYSE:CAL) and continued to build the positions on dips.

About a month ago, I thought the enthusiasm in these names was getting a bit pumped up. Combined with a flat oil price over the past month, I thought that the news would be baked in and the market would assume higher oil prices and lower airlines would be next. So I cut my AMR position in half and closed LCC.

Then a week ago, I realized that perhaps the airlines were stable and the rally would continue by the way they were reacting as oil moved up and down. From a valuation standpoint, some of the sector remained a buy in my eyes so I looked for a cheaper name with a steady trend that was tied to oil – I purchased UAL Corp (UAUA). A day later I added back to my AMR position based on the same stability premise. I only I wished I had purchased more!

Yesterday, there was news of LCC offering stock and cash to buy Delta (which is in bankruptcy). This has created a panic on the side of shorts I know and a mania among the analyst community who have buys and outperforms on the sector. One analyst I follow called this “rocket fuel” for the industry. Merger manias tend to lift prices but can also end a trend if the volatility rises too dramatically. Further, the history of mergers in the airline industry is not strong. I would also prefer at this point that the larger carriers remain independent because their RASM growth numbers remain strong and capacity is still stable. But alas, that is not the case.

Going forward, I think UAUA will be the cheapest of the names I follow. A further fall off in energy prices, notably jet fuel, would create even more earnings power for these names and thus cheaper situation. On the bearish side of the ledger, the fast money is going to move into these names raising the volatility in sector. I generally like to avoid high volatile names because the trends get somewhat cloudy and tough to gauge as supports and resistance levels disappear.

Bottom line: I remain a cautious bull on the airlines (and continue to hold my positions in the MIR 2). The valuations are still attractive in the names I own (and a few others as well). I still do not like Southwest Airlines (NYSE:LUV) or JetBlue (NASDAQ:JBLU) but it appears that the potential merger will take capacity out of the system – this would allow JBLU and LUV to expand. I will believe that when I see it!

Anyhow, based on my current estimates, I think UAUA, AMR and CAL are worth at least $50 each (and I could make a case for much higher valuations). At the same time, the trade will guide me going forward. After all, this rocket fuel will probably create a bunch of opportunities.

AMR vs. CAL vs. UAUA vs. LCC 1-yr chart:

airlines chart

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