U.S. Airline Stocks: Bargain-Hunters' Dream or Falling Knife?

Last week's punishment of the airline sector has provided loads of opportunity for those wishing to buy low. In fact, the AMEX Airline Index finished the week at a 15 year low of $18, almost $35 lower than its 52-week high of $53.

Soaring oil was the culprit for last week's bloodletting, although oil was up less than 5% on the week to the $135 mark, it did end up reaching a new all-time high and in the process, spooked investors into giving away their shares as panic dominated the Street with some stocks shedding as much as 50% (UAUA).

Analysts are talking the "B" word and credit agencies such as Fitch and S&P are busy downgrading many of the company's commercial paper. It's ugly and there is ample blood in the streets but losses for some, many times, end up creating gains for others, and buying the index at these oversold levels could provide substantial returns.

The Airlines are adjusting to high fuel prices quickly as many are in the process of enacting the following actions: (1) higher ticket prices (2) lower occupancy (3) fuel hedging contracts (4) overall cost cutting (5) consolidation within the sector (DAL merging with NWA) (6) charging for baggage, etc.

Many of the Airline's just emerged from Chapter 11 fairly recently with much less debt on their balance sheets as well as significant wage concessions from their various labor unions, so the entire industry has already been primed for a turnaround.

I wouldn't try and catch a falling knife at this juncture since the industry could slip further. There is no reason to argue with the market, no matter how irrational it may seem. It would be prudent to wait for the Index to start recovering before going long and not get in until the shares recover at least 10% above their lows—you might have to pay more, but it's well worth it, in order to be able to take advantage of the trend change.

The fund components include the following ticker symbols: AAI, ALK, AMR, CAL, DAL, GOL, JBLU, LCC, LUV, NWA, RYAAY, SKYW, TAM, and UAUA. All the carriers are domestic except GOL, RYAAY and TAM.

To illustrate how ridiculously low this index has reached, it's necessary to point out that the total market cap of the 14 components combined that make up the index is only $33 billion, yet these 14 companies generate sales of $136 billion per year equating to a price to sales ratio of 24% . In contrast, Yahoo's (YHOO) market cap is $5 billion more at $38 billion, yet YHOO's total sales are only $7 billion, making YHOO's price to sales ratio a very high 5.42. YHOO's price to sales ratio is almost 23 times higher than the AMEX airline's index. The comparison of these two ratios illustrate the significance of the "giveaway" occurring within the sector. Bargain hunters should take a closer look at this Index's holdings, because when the oil bubble eventually pops, we could see this fund quickly double.

Disclosure: None

Comments

[Victor J.Cook, Jr.]

Interesting article, Mark. The price/revenue ratio is a great metric -- simple to compute with powerful implications.

To place this metric in perspective you might what to see my paper "The Value/Revenue Ratio." In it I track that ratio over 56 years for all public companies. The long run expectation is about 1.0, but the semi-long run swings are even more interesting. See papers.ssrn.com/sol3/p...

Vic

[JonathanLiss, SAEditor]

Nice article Mark.

Considering the airline industry hasn't been profitable over its entire history, I fail to see the significance of the Price/Rev ratio. When companies the likes of Pan Am, TWA and Eastern all go out of business and with Delta and NWA just emerging from bankruptcy, isn't the bottom line what really counts when looking at the Airlines?

Curious for your takes Mark and Victor.

[cal48koho]

Falling knife, how bout falling guillotine. Many will fail as peak oil takes hold. Trying to pick which ones will survive is tough. The real money will be made shorting them. Long haul carriers with the most efficient aircraft and point to point connections avoiding hub and spoke nonsense will help but I see the airlines returning to a business model they had in the 30's and 40's with only the wealthy flying mostly between big cities and long flights. There are a lot of other sectors to make money in and most of the airlines will be gone or merged out of existence in the next 10 years or so IMO.

[Wez]

I'm thinking a couple major BKs in this sector will be time to start buying.