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US Airways (LCC) has enjoyed a remarkable run during the first half of 2012. After entering the year just above $5/share, US Airways has zoomed higher, touching a new 52-week high above $14 on Friday morning before closing at $13.88. US Airways has benefited from two major catalysts this year: speculation about a potential merger with bankrupt American Airlines (AAMRQ.PK) and falling oil prices. A merger could improve revenue trends at US Airways by vastly expanding its network and allowing it to win a greater share of the lucrative business travel market. Meanwhile falling oil prices have lowered US Airways' largest expense (jet fuel), which is particularly important because (unlike most other airlines) the company does not engage in fuel hedging.

I have been bullish on US Airways over the past few months; I recommended the stock as my #2 pick in the airline sector in late May, when it was trading at only $10. However, I now think that the upside and downside risks are roughly even at current prices. If oil prices resume their slide without further economic weakening, then the stock could make a move towards $20. On the other hand, if the economy plunges back into recession or oil prices spike back to their highs of earlier this year, the share price could fall back into the single digits.

It's easy to get drawn in to airline stocks by their low P/E ratios. Analysts currently estimate a profit of $3.07/share for this year at US Airways, and $3.54/share next year. Based on those numbers, US Airways currently trades at a P/E between 4 and 5, which usually indicates a significantly undervalued stock. However, low profit margins in the airline industry mean that airline P/E ratios are susceptible to rapid fluctuations as fuel costs and revenue trends change. For instance, US Airways uses more than 1.4 billion gallons of fuel annually. A change of 45 cents/gallon in jet fuel prices (roughly the difference between late April and today) has an impact of roughly $3/share on the bottom line over the course of a full year, holding revenue constant. That could double US Airways' profit, or wipe it out entirely, depending on the direction of the shift.

At this point, oil prices appear to have settled into a trading range between $2.70 and $2.90/gallon, and I think this is fully reflected in the current US Airways share price. It seems unlikely that fuel prices will fall much more except in the case of recession (which would cause offsetting revenue declines). US Airways (and other airlines) have seen slowing PRASM gains in recent months, as the economic environment has restrained further fare increases. US Airways also reported a lower load factor for the second quarter of 2012 than last year, which may indicate a slight softening of demand.

Furthermore, while I think a merger between US Airways and American Airlines would benefit both companies and the industry as a whole over the long term, a complicated transaction of that sort will likely result in turbulence along the way. United Continental (UAL) shares are still trading today at roughly the same level as they were when the merger closed nearly two years ago. Furthermore, it's possible that the proposed US Airways-American merger will fall through, in which case US Airways will just be facing a more formidable competitor (since American will lower its cost structure in bankruptcy).

A more attractive pick in the airline sector today is Hawaiian Holdings (HA). The company trades at a similar sub-5X P/E ratio. However, unlike US Airways, Hawaiian is a company that is rapidly growing, while still experiencing strong revenue trends. Hawaiian dominates its niche of flying to and within the Hawaiian islands, and has significant room for expansion of long-haul services to East Asia. The stock has performed well over the past few months, but still sits slightly below its January high, and has upside of at least 50% over the next six months, if strong revenue trends continue.

Disclosure: I am long HA, UAL.