6 Major Airline Stocks to Avoid for Now

Includes: AAL, DAL, JBLU, LUV, UAL
by: Investment Underground

By Amanda Jacobsen

When investing in the airline industry, there are a few major points to keep in mind. According to a paper by Cal Berkeley economist Severin Borenstein, the airline industry has lost $59 billion in domestic markets since deregulation. Even worse, most of those losses happened in the past 10 years. Who’s to blame? The 9/11 attacks hurt demand and a deep recession did little to restore it. Then throw in both rising labor inputs and frequent fuel price spikes year after year, and you can see why the major airlines' costs are exceeding their revenues.

The major airlines have worked hard at shedding capacity to better match passenger demand. Have you noticed that every flight you’ve been on has been packed to the brim? These guys don’t drive the pricing in many markets; the low carriers do. The majors are left to compete in an industry where they are without leverage on the cost side as well as on the revenue side.

And in an era of continually higher energy prices, many strapped consumers are simply going to be priced out of the domestic and international air travel markets.

Given the industry's historic losses, you might want to continuously ask yourself: Which airlines are not worth your dime? Here are six names we don’t like right now:

United Continental (UAL): United overpaid for Continental Airlines, and the company will face a tough job continuing to integrate the airline over the next few years. Competitors, both established and new, as well as significant fuel price increases, will hamper this company. Although UAL can grow revenues with higher ticket prices, it hasn’t been able to narrow the cost differential that exists with the low-cost airlines like Southwest (NYSE:LUV). We can expect mid-margin expansion due to synergies developing, albeit at half the $1 billion figure offered by management. We value shares at $23 apiece, using a 12% discount rate.

Delta Airlines (DAL): Delta should be able to grow revenues at a 7% clip and keep margins around 6%. The monster of fuel prices will hamper any real growth for the company, along with its high debt load and large number of ancient, fuel-inefficient aircraft. Periodic battles for market share with other established and newer players in the industry will keep a lid on Delta. We value shares at $10 apiece, using a 12% discount rate.

Southwest Airlines (LUV): Despite a successful hedging program in the past, Southwest is likely to be hampered by fuel costs and poor service. Peaked schedules with close connection times makes for tough operations. The proof is in the data: It is now last in on-time departures. At 30% of expenses, fuel, coupled to an 80% share of unionized workers, should cost Southwest its ability to produce a return on invested capital in excess of its cost of capital. Shares are worth $11 apiece, using a 12% discount rate.

US Airways Group (LCC): This airline should be able to grow revenue in the mid-single digits and cost-cutting at US Airways should produce margins of 4-5% over the next few years. Again, fuel costs, already above 20% of expenses, will likely compress margins and deplete the impact of cost-cutting measures. The expansion in Europe, South America and Asia continues to spread the costs thin. Also, 90% of company workers are unionized and will create a substantial burden on the company’s ability to return any cash to shareholders. Shares are worth $8 apiece, using a 12% discount rate.

JetBlue (JBLU): This national carrier should be able to control fuel costs better than its peers and increase revenues from complementary services to passengers. Sudden changes in fuel prices will still cramp future earnings and cash flow to the company. JetBlue faces extra risks not borne by other airlines due to its thin expansion into new markets. It also faces the prospect of full-scale unionization of employees. We value shares at $3.50 apiece, given its high debt-to-capital ratio around 2:3.

AMR Corporation (AMR): American Airlines faces fuel costs accounting for 25-30% of its operating budget. Most of its stateside employees are unionized and locked into two-year contracts, which tends to result in wage spikes at each interim. New members in the airline industry peel away valuable revenues to AMR. The poor performance and the firm's higher labor costs are a result of AMR's skipping around bankruptcy in the past decade, while others washed away costs during the process. The company’s pension plan is also underfunded. Shares are worth $7 apiece, assuming 5.5% margins and mid- to high-single digit revenue growth over the next few years.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.