Investing in airline stocks has been a risky activity for at least the past decade. Major airlines have been dealing with legacy costs, high energy prices, recessions, increased security expenses, and competition from smaller and nimbler rivals. In this article we will focus on Delta (NYSE:DAL) and its bigger rivals. DAL has a B credit rating from Standard & Poor’s. The rating agency said “it believes the carrier will continue to post healthy earnings despite the weak economy,” reports Businessweek. DAL reported a third quarter loss of $161 million, or 19 cents a share. The company lost $50 million, or 13 cents a share, in the year-ago period. The question is whether these issues are enough to preclude DAL or if the airline is worth the chance. To get an idea whether DAL is worth the investment, we'll look at the company in closer detail and compare its performance to its closest competitors – United Continental (NYSE:UAL), US Airways Group (LCC) and AMR Corporation (AMR).
First, we will look at the P/E ratio. This metric divides a company’s share price by its earnings per share – the lower the number, the better. P/E ratio indicates how many times its earnings a company is trading at. If the P/E ratio is high, the stock could be overpriced, so the lower the better. P/E ratio data was not available for DAL because of the negative earnings, but its forward P/E ratio is very low at just 7.1. To make sure we compare apples to apples, so to speak, we will look at its competitors’ forward P/E ratios. In so doing, we can see that DAL is on par. LCC has a forward P/E of 22.6 while UAL has a forward P/E of 5.1. No P/E or forward P/E ratio information was available for AMR because of negative earnings.
Next, let’s look at the earnings growth consistency and expectations. Expected growth estimates can be wrong. In fact, they are frequently overstated, but they can be useful when comparing companies or comparing a company’s performance relative to its industry. DAL’s earnings are forecasted to grow by 3% over the next five years compared to 8.4% for its industry. UAL’s earnings, LCC’s earnings and AMR’s earnings are each expected to grow by 3% in the next five years. The similarity could be due to the fact that each of the four companies we are reviewing is a major airline. Looking at a regional airline like JetBlue, the expected growth is 6%.
We used beta as a measure of risk. A beta of 1.0 means that the stock moves with the market. The higher a stock’s beta, generally, the more volatile the stock, and, as a result, the more risky. A lower beta tends to indicate that the stock moves more independently from the market. UAL has the lowest beta of the four companies we looked at, coming in at 0.83. LCC was next at 0.96, followed by AMR at 1.29 and finally DAL at 2.50.
HEDGE FUND OWNERSHIP
Stocks that are favored by hedge funds tend to outperform the market by a few percentage points on the average. Each of the funds we looked at has a fair amount of hedge fund ownership. DAL is the most popular with hedge fund managers. Of the 300+ funds we track, 40 had positions in DAL at the end of the second quarter. UAL was the next popular with 38, followed by LCC and AMR, which were tied at 17.
THE BOTTOM LINE
Overall, we like UAL the best because of its lower PE ratio. Delta comes second. UAL may have had some ups and downs but it looks like it is in a good position to bounce back. Both DAL and UAL are consistent performers and have strong hedge fund interest, plus they are priced right according to their forward P/E ratios. Regional airlines can also be good investments because of their higher growth rates. These smaller airlines have much lower legacy costs and are nimbler than their bigger rivals. However, their price multiples are also relatively higher. Southwest Airlines (NYSE:LUV) has a forward P/E ratio of 11.16, an EPS of $0.21 and a 1.10 beta, while JetBlue Airways (NASDAQ:JBLU) has a 8.94 forward P/E ratio, $0.25 EPS and a 0.96 beta. The growth estimates for the third quarter pointed that US economy won’t be experiencing a recession despite all the doom. This may be a good time to invest in these cyclical stocks.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.