Are Airlines Stocks a Contrarian Opportunity?

By Eric Roseman

Skyrocketing energy prices are making the headlines almost daily since last spring. Over the last 12 months, crude oil prices have more than doubled and gas prices are heading to US$5 per gallon.

Meanwhile, out in the financial markets, investors are blindly buying energy stocks. Commodity fund managers are lunging after crude oil and natural gas futures. A full-blown mania now surrounds the energy pits.

In just about every facet of global business and consumer livelihood, high energy prices are wreaking havoc. Prices are rising, if not soaring, for most goods across the world. Oil’s ubiquitous role is forcing consumers and companies alike to boost spending, reducing discretionary income and slicing corporate profits.

Oil’s “Unstoppable” Prices Are Yesterday’s News

But surging oil is yesterday’s news. Demand destruction is underway. There will be a point when high prices finally force consumers to use less oil products, buy less gas and other distillate fuels. Granted it doesn’t seem like it, but consumers are already buying less gas since April.

What Goes Up WILL Come Down: Oil’s Path This Year

Since March 31st, crude oil prices have soared more than 35% — an astonishing rally in a short period of time. At some point, a correction looms. That’s when some sectors suffering from expensive oil will post some spectacular gains. That includes my absolute favorite contrarian play right now: Airlines.

The Worst Business in the World

Yes, I know the airline industry is arguably the worst business in the world right now.

Soaring jet fuel prices, expensive labor costs and rising airport user fees are forcing carriers worldwide to cut routes, reduce capacity, and shed labor. Many analysts forecast several big carriers, mostly in the United States, will probably collapse this year if jet fuel prices remain at these elevated levels.

In fact, you could say airline stocks have been a one-way ticket to the poorhouse lately. That’s certainly been the case over the last 18 months as input costs have surged, mainly because of a 100%-plus rally for jet fuel.

Airline stocks also earn the dubious ranking as the worst performing sector of the market over the last 12 months — even worse than the financials!

Since June 2007, the AMEX XAL Airline Index of global carriers has collapsed a formidable 62%. Over the same period, jet fuel prices have doubled. Airlines have cut capacity. Also, executives in the business are warning that we’re facing the worst economic climate for the industry since 9/11. In short, these are dark times for airline executives, employees and passengers.

Notice: It’s the Exact Opposite of Oil in the Airline Sector

How Many Airlines Do You Know that Are Raising Dividends?

Historically, I’ve avoided the airline sector like the plague. I’ve only turned bullish on this sector a handful of times in my 16-year investment career.

But at these bombed-out levels and ultra-low valuations the airlines are just too contrarian to ignore. Plus, I see a major catalyst coming for rapid price appreciation in the airlines on the heels of lower oil prices in the months to come.

I’m now buying one of the best-managed airlines in the world. This blue-chip company just raised its dividend again recently. The stock now pays an effective 8% per annum in one of the world’s strongest currencies. That yield is almost twice the rate paid by 10-year bonds in the United States and Europe.

This stock is also trading at a 52-week low, still earning profits and has most of its jet fuel hedged at about US$75 per barrel. How many airlines do you know that are still making money, yet alone raising dividend payments?

The way I see it, if oil prices suffer a 20% correction or more, which is highly likely after a nonstop blistering rally since last summer, industries leveraged to the price of oil or in this case, jet fuel, will rocket higher.

Since the advent of the sub-prime debacle in July 2007, every segment of the commodity bull market has suffered a correction — except the energy complex. The rally has literally been unstoppable so far.

Go Against the Herd for the Best Profits By Christmas

All secular bull markets face corrections — even oil. These corrections tend to be brutal. So you can expect oil prices to post a savage correction. When that happens, the industries that have been handcuffed by high oil prices will post major reversals — including the best-managed airlines.

Plus, global governments are now throwing everything they can at high oil prices, including the Saudis, so the odds of a brief respite are growing more likely by the day.

If oil prices decline, as I expect them to, then input costs for all carriers will decline markedly, if even for just several months. There is certainly enough room to juice this speculation for at least a quick 35% to 50% profit, possibly more. Plus, add some dividends into the picture, profitable earnings, and a big bear market rally and you should hit a home-run in airlines before December.

Sometimes, it pays to look the other way behind the trail of a blazing bull market in energy prices. In this case, some airlines will reward investors with big profits over the next 6-12 months. I’m betting on it.

Source: Why the World’s Worst Business Is Now One of the Best Buying Opportunities on the Planet

 

Comments

[spot1roth]

I absoultely agree, there has to be a correction in the oil patch. The only question is when? When it happens, I feel sorry for the poor people who are long as they will not be able to get out before losing most or all profits and airline will at least double to triple.

[Ashish S]

The trade as you present it is simply a leveraged bet on the decline of oil prices. If that is your view, I don't see why you wouldn't make a more direct bet on oil, like buying puts.

Also, if you are most bullish on the airline that is "best managed" primarily on the basis of hedging its oil exposure, wouldn't this airline have the least to gain from a correction in oil prices? Airlines that have been punished because of insufficient hedging would gain much more. In fact, you might be best off shorting the hedger and going long another to really capture your view on oil prices declining.

[Fam62c]

Don't forget to talk about the risks. Many of these airlines (except LUV where you will gain the least if oil prices drop) will get dangerously close to bankruptcy if fuel prices don't drop rapidly very soon. When these companies pull the plug it happens very quickly with very little warning. I like JetBlue (JBLU) here as a bet (and I mean BET like at the roulet wheel) because they have a high percentage of insider ownership and Lufthansa owns 19% of the company. They may actually view bankruptcy as a bad thing unlike the major airlines who consider it a solid business strategy. They also have a good product and lower operating costs than the large major airlines so they may be able to make money and see opportunity where other carriers can not. If things turn around and oil drops this one will shoot up like a rocket. Beware though: if fuel stays up or goes up more for a prolonged period JBLUE will run into a liquidity crisis fast.

[NormanQ]

I agree with you Fam62c. Dabbling in airline stocks now is speculation. Buy small amounts of a few airlines or buy one and let it ride, because it is betting. I wanted to get in with AMR a few months ago. Boy am I glad I didn't. These are stocks where you have a decent chance of losing everything. If you have a local casino closer to you, it might be the better thing to put all your money on black then to sit and wring your hands in the markets for 6 months waiting for your stock to rebound or go into BK. I like JBLU too. They have a good product, and a "better" business model than the big dinosaurs (AMR, DAL, NWA, LCC).

[DaveinHackensack]

Jim Rogers mentioned he was investing in airlines recently, though I doubt he's buying any U.S.-based ones. In addition to high oil prices, the deregulated U.S. market is hyper-competitive, so airlines have struggled to profit even with relatively low energy prices.

If you are looking to make a bet on a short-term correction in the secular bull market in oil, a lower-risk play may be to buy shares of a solid, pure-play oil refiner such as FTO. A drop in oil prices will widen crack spreads and profit margins for refiners.

[borisb]

I agree. I have followed a low cost carrier Jetblue for a long time. The price of the shares have been kicked down to $3.50 a share which i find incredibly low. the company gets high marks from customers and industry ranks and i doubt they go out of business.

[LarryS]

What airline pay an 8% dividend?

[fatcat]

I've been playing the oil bubble buying calls on Valero.Obviously,it hasn,t worked yet ,but it seems to be a better way than shorting oil directly..

[sf94127]

I agree except if oil gets to $170 that could literally drive UAUA and AMR into bankruptcy. LUV will survive unless crude gets to $250, which could happen. I carry some airline stocks as a hedge against a fast oil drop.

[BioInvestor]

fatcat, did you mean puts? How does buying calls help if Valero drops?

[BioInvestor]

sf94127, I don't see AMR going into liquidation. The weakest carrier is probably LCC, though it is close. They may enter reorganization, but the complete liquidation of one of the legacy carriers will be good for the rest.

[ual747retired]

So... why has no one figured out "the best run airline" yet? There are probably only 3 or 4 that might qualify!

[James Cullen]

Only reason I can see myself buying stock in a US airline is if it trades under the scrap value of the metal that goes into the jets...

[Airline]

Look at the results for the airlines in 2007, quite a few airlines reported outstanding growth/profits.

Now with oil being what it is today, more airlines are adjusting to the economic realities of today, taking a hard look at the business side and how to manage the operation at today's fuel prices.

If and WHEN the oil prices return to historical levels, the airlines should reap the benefits of today's cost-cutting measures.

[sf94127]

Opinions on the bottom for UAUA, AMR, and LUV; assume oil will go to 150.

[ceejay]

Looks like UAUA at just above 4 bucks is at the bottom.

[MNSL]

Oil correction is happening now. Your are 100% correct.