Are Airline Stocks Cheap Enough Now?

While the transportation sector has been going strong, the airline industry - a sub-sector of transports - is scraping the bottom of the graph at multi-year lows.

Imagine how well the transportation index would be doing if the airlines had been contributing or at least keeping up with the rest of their peers. Accounting for almost 11% of (dead) weight, the following airlines are in the Dow Jones Transportation Index:

• AMR Corp. (AMR)
• Continental Airlines Inc. (CAL)
• JetBlue Airways (JBLU)
• SouthWestern Airlines (LUV)

Recently there’s been some turmoil in this sector with a few bankruptcies, fleets being grounded and just today, Northwest Airlines (NWA) and Delta (DAL) deciding to merge. This sort of shake-up is commonplace in this sector and it happens ever few years. Airlines are a notorious black hole for capital: Even the Sage of Omaha, Warren Buffet, lost his shirt when he strayed too close.

But do the extremely “cheap” airline stocks mean that this sector is a buy? Or put another way, are they cheap enough?

From a fundamental point of view, I can’t say that I have a clue. But from a technical perspective, I don’t think so. Here’s why:

click to enlarge

The really important double bottom that was formed in the end of the last bear market was at 30. In January 2008, the AMEX Airline Index (XAL) ricocheted higher after grazing the same level. But in contrast to before, the ensuing rally was short lived and it subsequently fell below that important support line.

So right now the index is approaching the 30 level again but now it is facing it from below, as resistance, rather than support. That’s an important distinction.

Also, it is no longer in step with the parent sector (transports). The bullish percent index for the Dow Jones Transportation Index is at 55% while it was at 15% and lower in 2003. I am too lazy to look up the Airlines bullish percent index but my hunch is that it would be wallowing in the 10-20% range.

So I wonder… why does the market shrug off all the reasons why the land and sea transportation companies’ stocks should be sold (high energy costs, recession, etc.) but not the airlines?

Finally, taking a look at the component stocks tells me that they are either below or far away from a base or support level. Take for example, JetBlue (JBLU): In March 2003, when the airline sector put in its major multi-year bottom, JBLU traded at $10/share. It is now trading at $5.18/share. Almost half that level.

The opposite could be said of AMR because it traded at $2.50/share in 2003; which means that it still has a lot of potential room to fall from its present level of $9.34/share.

Comments

[brownsteve]

You say, "Airlines are a notorious black hole for capital: Even the Sage of Omaha, Warren Buffet, lost his shirt when he strayed too close."

Wrong. Buffett made a profit on his famous (or infamous) investment in US Air, though he did berate himself for making that investment in the first place. See the excerpt below from an April 3, 2000 Motley Fool article by value fund manager Whitney Tilson.







US Airways Case Study

"When Richard Branson, the wealthy owner of Virgin Atlantic Airways, was asked how to become a millionaire, he had a quick answer: 'There's really nothing to it. Start as a billionaire and then buy an airline.'" -- Warren Buffett's 1996 annual letter.

Tiger owns 23% of US Airway's shares, representing Robertson's largest position by far. To my knowledge, this is the only stock in Robertson's current portfolio that Buffett has ever owned (in 1989, he bought $358 million of USAir preferred stock). Here is what Buffett wrote about this investment in various annual letters:

"There is no tougher job in corporate America than running an airline: Despite the huge amounts of equity capital that have been injected into it, the industry, in aggregate, has posted a net loss since its birth after Kitty Hawk." -- 1991 annual letter.

"A competitively-beset business such as USAir requires far more managerial skill than does a business with fine economics. Unfortunately, though, the near-term reward for skill in the airline business is simply survival, not prosperity." -- 1992 annual letter.

"Mistakes occur at the time of decision. We can only make our mistake-du-jour award, however, when the foolishness of the decision become obvious. By this measure, 1994 was a vintage year with keen competition for the gold medal. Top honors go to a mistake I made five years ago that fully ripened in 1994: Our $358 million purchase of USAir preferred stock, on which the dividend was suspended in September. In the 1990 Annual Report I correctly described this deal as an 'unforced error,' meaning that I was neither pushed into the investment nor misled by anyone when making it. Rather, this was a case of sloppy analysis, a lapse that may have been caused by the fact that we were buying a senior security or by hubris. Whatever the reason, the mistake was large." -- 1994 annual letter.

Ironically, as Buffett was writing those words in early 1995, USAir was beginning a remarkable rise from the ashes. From its low in late 1994 to its peak in mid-1998, the stock rose more than 2,000%, which allowed Buffett to exit his investment profitably in 1997.