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American Airlines parent AMR Corp. (AMR) bankruptcy announced on Tuesday has created a short-term trading opportunity in both legacy carriers and regional airlines that may benefit from customers avoiding American during the restructuring period. The airline industry as represented by the AMEX Airline Index ($XAL) has been weak recently, down by 40% from the peak in November 2010, based on the weak global economy and higher fuel prices, as well as natural and political calamities in Africa, the Middle East, and Japan that have hurt demand. However, long-term, the industry is expected to post strong growth, and many stocks are trading at attractive levels.

In this article, via an analysis (based on the latest available Q3 institutional 13-F filings), we identify the airline group companies that are being accumulated and those being distributed by legendary or guru fund managers, such as Warren Buffet, George Soros, Carl Icahn, Steven Cohen and Mario Gabelli, based on our extensive database of the buying and selling activities of over 60+ such managers. We have included in the group not just passenger and cargo airlines, but also aircraft manufacturers and air travel service companies.

We then crossed that data with the airline group companies that are trading at value prices, based on their projected earnings for FY 2012, operating cash flow on a trailing-twelve-month (TTM) basis, and other valuation measures such as price to book (P/B) and price to sales (PSR) ratios, and came up with a list of undervalued companies in the group that are being accumulated by these legendary or guru fund managers, and those being distributed by them. The hedge fund and mutual fund managers included in this select group include only high profile names who by virtue of their long-term market-beating returns have earned their standing in the investment community and are worthy of our attention. They include well-known names such as those mentioned above, as well as perhaps relatively lesser-known names that also have a stellar long-term history of beating the markets, such as Seth Klarman, John Griffin, Prem Watsa, Robert Karr and Lee Ainslie.

We determined based on our analysis that guru fund managers are bearish on the airline group, and they are slightly under-weight in the group. During the September quarter, these guru fund managers together cut a net $73 million from their $4.10 billion prior quarter position in the group, selling $970 million and buying $898 million worth of stocks in the group. Furthermore, overall they are slightly under-weight in the group by a factor of 0.96; that is taken together guru funds have invested 0.9% of their capital in the airline group compared to the 1.0% weighting of the group in the overall market.

The following are the airline group companies that guru fund managers are bullish about, and that are also trading at a discount to their peers in the group:

United Continental Holdings (NYSE:UAL) provides air transportation for passengers, freight and mail with over 5,675 flights daily to over 372 airports on six continents. Guru funds added a net $49 million to their $237 million prior quarter position, and taken together guru funds hold 4.8% of the outstanding shares, significantly more than their 2.5% weighting in the group. The top buyer was Capital Growth Management ($142 million) that initiated a new position in UAL in Q3. The top guru holders are Capital Growth, Appaloosa Management ($70 million) and Blue Ridge Capital ($53 million).

Overall, 330 institutions hold 96.3% of UAL shares, with Capital World Investors ($465 million), Janus Capital Management ($451 million), Fidelity Investments ($439 million), and Wellington Capital Management ($435 million) being the largest holders with 8.5%, 8.2%, 8.0% and 7.9% of the outstanding shares respectively. UAL trades at a discount 3.4 forward P/E compared to the 10.7 average for its peers in the airline industry, while earnings are projected to rise at a 15.1% compound growth rate from $3.96 in 2010 to $5.25 in 2012. Also, it trades at a 2.4 P/B and 2.6 P/CF compared to averages of 1.8 and 4.5 respectively for its peers in the airline industry.

Delta Air Lines Inc. (NYSE:DAL) provides international and domestic passenger and cargo transportation in the U.S. and abroad, offering services to 357 destinations in 66 countries. Guru funds added a net $66 million to their $204 million prior quarter position, and taken together guru funds hold 3.9% of the outstanding shares, significantly more than their 2.5% weighting in the group. The top buyer was Capital Growth Management ($138 million) that initiated a new position in DAL in Q3. The top guru holders are Capital Growth and Blue Ridge Capital ($95 million).

Overall, 392 institutions hold 81.9% of DAL shares, with Janus Capital Management ($481 million), Wellington Capital Management ($443 million), and AllianceBernstein ($342 million) being the largest holders with 7.7%, 7.0% and 5.4% of the outstanding shares respectively. DAL trades at a discount 3.4 forward P/E compared to the 10.7 average for its peers in the airline industry, while earnings are projected to rise at a 15.2% compound growth rate from $1.71 in 2010 to $2.27 in 2012. Also, it trades at a 5.2 P/B and 3.3 P/CF compared to averages of 1.8 and 4.5 respectively for its peers in the airline industry.

JetBlue Airways Corp. (NASDAQ:JBLU): JBLU provides passenger airline service to 63 destinations in 21 states, Puerto Rico, and Mexico; and 10 countries in the Caribbean and Latin America. Guru funds added a net $2 million to their $114 million prior quarter position, and taken together guru funds hold 9.0% of the outstanding shares, significantly more than their 2.5% weighting in the group. Donald Smith & Co. is the only guru fund with a significant holding in the company, at $115 million at the end of Q3.

Overall, 213 institutions hold 86.5% of JBLU shares, with Fidelity Investments ($151 million), Donald Smith, Goldman Sachs ($75 million) and PRIMECAP Management ($70 million) being the largest holders with 13.9%, 10.1%, 6.9% and 6.4% of the outstanding shares respectively. JBLU trades at a discount 8.1 forward P/E compared to the 10.7 average for its peers in the airline industry, while earnings are projected to rise at a 24.4% compound growth rate from 31c in 2010 to 48c in 2012. Also, it trades at a discount 0.6 P/B and 2.2 P/CF compared to averages of 1.8 and 4.5 respectively for its peers in the airline industry.

Republic Airways Holdings (NASDAQ:RJET) is a holding company for Chautauqua Airlines, Frontier Airlines, Republic Airlines and Shuttle America offering 1,600 flights daily to 133 cities. Guru funds added a net $3 million to their $33 million prior quarter position, and taken together guru funds hold 17.2% of the outstanding shares, significantly more than their 2.5% weighting in the group. Donald Smith & Co. ($19 million) and Greenlight Capital ($13 million) are the only guru funds with a significant holding in the company at the end of Q3.

Overall, 104 institutions hold 77.6% of RJET shares, with Donald Smith, Fidelity Investments ($15 million), and Dimensional Fund Advisors ($14 million) being the largest holders with 10.1%, 7.9%, and 7.5% of the outstanding shares respectively. RJET trades at a discount 5.3 forward P/E compared to the 10.7 average for its peers in the airline industry, while earnings are projected to fall from 85c in 2010 to 73c in 2012. Also, it trades at a discount 0.3 P/B and 1.1 P/CF compared to averages of 1.8 and 4.5 respectively for its peers in the airline industry.

Select stocks that guru funds as a group are bearish on (see Table) include online travel services provider Priceline.com (NASDAQ:PCLN), in which they cut $49 million from a $1.18 billion prior quarter position; online travel services provider Expedia Inc. (NASDAQ:EXPE), in which they cut $234 million from a $531 million prior quarter position; and Gol Linhas (NYSE:GOL), a provider of low-cost low-fare airline services in Latin America, in which no guru fund held a position at the end of Q2/Q3. Furthermore, besides the undervalued positions listed above, guru funds as a group are also bullish on US Airways Group Inc. (LCC), in which they added $7 million to a $75 million prior quarter position; and Southwest Airlines Co. (NYSE:LUV), in which they added $23 million to a $35 million prior quarter position.

Table


(Click to enlarge)

General Methodology and Background Information: The latest available institutional 13-F filings of over 60+ legendary or guru hedge fund and mutual fund managers were analyzed to determine their capital allocation from among 50+ different industry groupings, and to determine their favorite picks and pans in each group. Each guru has been carefully selected based on their long-term performance and standing in the investment community. Furthermore, the credentials of most of the 60-odd guru funds that justify their inclusion in this elite group were detailed in our previous articles, many of which can be accessed by clicking on the hyperlinks referencing them in the above Table and in the article.

These legendary or guru fund managers number less than one percent of all funds and yet they control almost ten percent of the U.S. equity discretionary fund assets. The argument is that institutional investors have the resources and the access to information, knowledge and expertise to conduct extensive due diligence in informing their investment decisions. When high alpha generating or guru Institutional Investors by virtue of their fund performance, low volatility and elite reputation in the investment community, invest and maybe even converge on a specific investment idea, the idea deserves consideration for further investigation. The savvy investor may then leverage this information either as a starting point to conduct his own due diligence or even go as far as constructing a model diversified portfolio based on the guru funds best picks.

This article is part of a series on institutional holdings in various industry groups and sectors, and other articles in the series for this and prior quarters can be accessed from our author page.

Disclaimer: Material presented here is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion. Further, these are our ‘opinions’ and we may be wrong. We may have positions in securities mentioned in this article. You should take this into consideration before acting on any advice given in this article. If this makes you uncomfortable, then do not listen to our thoughts and opinions. The contents of this article do not take into consideration your individual investment objectives so consult with your own financial adviser before making an investment decision. Investing includes certain risks including loss of principal.

Source: Airline Group: Q3 Undervalued Picks By Legendary Money Managers