Airline Stocks: Where Value Investing Takes Flight

Jim Cramer has said it, the Wall Street analysts have said it and some of the most respected money managers have said it: Don't own an airline stock! Apparently people are listening. They are listening so attentively that the airline prices have fallen drastically. Possibly even too drastically.

That's not a very popular train of thought right now with oil prices nearing $150 a barrel. However, with the prices of the airline stocks so low, it is hard for the long term investor not to consider purchasing them.

Not all airlines are created equal, however. There is one problem with the pending merger between Northwest Airlines Corporation (NWA) and Delta Airlines Inc. (DAL) that should keep likely investors away. That problem is that if the market were to get wind of even the slightest possibility of a threat to this merger then these already depressed stock prices will become... well, even more depressing.

AMR Corporation (AMR) the parent company of American Airlines, was one of the few airlines that was able to fight off bankruptcy in the early 2000's and it seems like they may now pay the price for that. Their efforts, however valiant, to keep the company out of bankruptcy protection means that they now have mounds of debt and little cash with which to pay off this debt. For their most recent quarter ended March 31, 2008 they reported only a meager 208 million on the balance sheet with 9.57 billion in current liabilities to pay off and 9.3 billion in long term debt. They were able to earn 5.7 billion in revenue on 4.8 billion cost of revenue meaning that they were able to earn 1.1875 dollars for every dollar spent, but they still come out with a net loss of $1.32 a share. This is one airline that a prudent investor would not want to go near despite its attractive price.

UAL Corporation (UAUA) the parent company of United Airlines much like AMR Corporation is drowning in debt. For their most recent quarter they reported 8.2 billion dollars in current liabilities and 7.3 billion in long term debt. They do have some cash on hand in the amount of 2.4 billion dollars, but the most horrifying fact that about UAUA that is likely to scare off any potential investor is their cost of revenues. For their most recent quarter they were able to earn 4.7 billion in revenue, but their cost of revenue was 4.6 billion. No company can operate under margins like these for too long. Investors be warned!

It is indeed true that there are some airlines that investors should steer clear of, but there are also a few that might be worth owning at such attractively low prices. There are three in particular: US Airways Group (LCC), Continental Airlines Inc. (CAL) and Alaska Air Group (ALK). These companies boast some decent revenues to cost of revenues ratios for their most recent quarter at 1.368, 1.119 and 1.694, respectively. All three of them also have adequate cash on hand in relation to the size of their business that they all can fight off bankruptcy despite high oil prices for at least two years. LCC has 1.9 billion in cash, CAL 2.2 Billion and ALK 212 million. The truth still remains that the airline industry is not a profitable one at this point, but still these three stocks look like a safe long term investment at bargain basement prices right now.

The biggest factor that every airline has to worry about is the price of oil. With a price of close to $150 a barrel, no airline can be expected to make profit. If this $150 price were sustained for any period of time then eventually all of the airlines would fall into bankruptcy if regulators were not to step in. There seemed to be no stopping the oil run-up until just recently when the first signs of downward pressure started to show themselves. Not only will $150 be a major resistance level for oil to break, congress and the CFTC are now investigating the role of speculation in the oil market. These occurrences may be the beginnings of a pullback in the oil market meaning that the airline stocks may see a short term run-up due to their "inverse of oil" movement.

The bottom line is that airlines are not making money right now, but with prices so low it is hard not to consider buying some of the healthier airlines. An airline with the ability to fight off bankruptcy for two years or more means that an investor can pick up a healthy amount of that airline's stock and then hold on to it until the oil market straightens itself out and the airlines return to profitability. For the traders out there, look for oil to hit near $150 a barrel and then do a pullback meaning that the airlines will see a temporary bounce just perfect for option traders.

Disclosure: No positions

Comments

[AmesTiedeman]

Only if oil drops hard and only for a trade.

[BS Detector]

Interesting market - LUV is likely the best US airline, long term, and has been able to hedge fuel where others have not. Similarly, RYAAY is a very healthy European airline, which has also hedged fairly well. However, since they have been better able to hedge, they should not bump as much when oil falls. So if you're looking for a trade, these aren't it.

The question for AMR is a matter of time; does oil come back to earth before it runs out of cash?

[BioInvestor]

I want to make a couple of points on AMR to clarify the statements made in the article. I think that the analysis of the financial statements doesn't paint the entire picture. (I do think at some point it's probably in AMR's best interest to reorganize.)

While AMR has under $1 billion in cash, it has almost $4.9 in cash equivalents. The company has reduced its accounts payable by $5 billion: I am waiting to see exactly why this step occurred. The company is burning cash, but is solvent. Contrast this picture with the one five years ago, where shareholder equity was negative.

The statement that AMR is drowning in debt isn't wholly accurate, since the legacy carriers are all highly leveraged. An analysis of all the legacy carriers shows that AMR is in a better position than many of its peers.

In contrast, UAUA has weaker cash (and cash equivalent) position than AMR. Looking at income, the company performed worse than AMR in the latest quarter. Just like AMR, UAUA is bleeding cash.

Overall, AMR is in a better position than is UAUA.

LCC is an interesting case as it definitely benefited from its reorganization. The company still has challenges with the US Airways/American West merger. I haven't looked at the June numbers for LCC, but its income is trending in the wrong direction. Long term, LCC has a poor hub structure. LAS and PHX are areas of growth, but PHL isn't a good international gateway; PIT is a problem for the airline. CLT has advantages in terms of traffic, but it too isn't a good international gateway. Long term LCC, in my opinion, isn't going to be a winner.

Just like AMR, CAL has pretty stable revenues despite current market conditions. The company has, arguably, the strongest balance sheet of any of the legacy carriers. Its EWR hub is an excellent international gateway; IAH is a strong hub for Central and South America. CLE doesn't appear to add much in the way of value for the company. CAL lacks exposure on the west coast--it needs a hub. Of course, since the company will be one of the first to take delivery of the B787s, whenever they're ready, the airline will expand into Asia from its IAH and EWR hubs. CAL leases most of its fleet--it owns some regional jets. It's more difficult for CAL to park aircraft. It also can't raise funds against equipment as easily as, say, UAUA could. CAL is unlikely to enter C11, but leasing poses some downsides. CAL also owns many of the aircraft used by Express Jet (XJT), a company spun off from CAL a few years ago. Like CAL, XJT looks to have a strong balance sheet and relatively stable income; however, the company has very serious cash flow problems. Its stock price has collapsed (bigcharts.marketwatch....); the company should be delisted from the NYSE later this month or early in August. If XJT fails, CAL will be stuck with a number of non-performing assets: Embraer regional jets, which won't be helpful to its cause. CAL is, IMHO, still the strongest of the major, legacy carriers.

ALK has a weakening cash position; it does have relatively stable income and a relatively healthy balance sheet. Its cash position is actually weaker than many of the legacies. ALK is in a relatively good market where it has been able to compete quite successfully with LUV. It has done well and will likely continue to do well in the future.

The lesson learned from XJT, which is a great lesson for the airline industry, is to take a look at cash flow. The balance sheet is the past; the statement of cash flows is the future. I don't think that any of the legacy carriers represents a good investment opportunity right now. None of them is safe. At current oil prices--and the trend in oil prices--each carrier is in peril. My suggestion is to wait for the first legacy carrier to enter C11 (it would well be LCC), which would be good for the rest. Of the three listed in the article, only ALK and CAL are worth consideration from a committed investor. I wouldn't buy either right now; I would wait for major calamity in the industry, then purchase.

[notsosmart]

qoute"if you want to be a millionaire start out as a billionaire & invest in airline stocks. never made a penny on any airline stock.luckily i dont have to fly anymore either.

[Phil Obal]

Airline industry is a tough market. Huge investments in infrastructure and people - whether flying or not - you still have to maintain and pay ALL of that infrastructure. Every time you fly... look out at all the equipment that is needed at each gate plus personnel.

Therefore, I avoid airline stocks like the plague. Southwest is the only profitable long-term player in the US market.

[ProfessionalHFAnalyst]

If memory serves, no US airline has ever returned its cost of capital. Even in the good times. Until there is a cartel/monopoly established where tickets can be sold at multiples of current prices, I would avoid this sector at all costs.

[buyforeclosures]

If LCC goes to 2.00 I am buying. 2 years is a LONG time and chances are VERY good they merge and Oil is settled ...LCC at 2 bucks is a 4-5 bagger in 2 years and maybe more. Think about it

[Mark S.]

AMR will be a good short-term buy - today it went up 11+%. You trade these things. You don't invest in them. I think some of these airline stocks will be good bets against oil stocks as oil prices drop. I just wouldn't put all of my eggs in one basket and I wouldn't keep my money in them for long-term. Still, if you're looking at a safer play against oil, DUG looks like a good ETF.

[BioInvestor]

Sad but true: none of the legacy carriers has. Southwest isn't part of this conversation.


On July 8, ProfessionalHFAnalyst wrote:

If memory serves, no US airline has ever returned its cost of capital. Even in the good times. Until there is a cartel/monopoly established where tickets can be sold at multiples of current prices, I would avoid this sector at all costs.

[BioInvestor]

I think trading airline stocks is the only way to generate any kind of return. It would surprise me if AMR went into C11, but I think in the short term--say the next year or two--it's not a bad trading vehicle for those that are looking for short term returns.


On July 8, Mark S. wrote:

AMR will be a good short-term buy - today it went up 11+%. You trade these things. You don't invest in them. I think some of these airline stocks will be good bets against oil stocks as oil prices drop. I just wouldn't put all of my eggs in one basket and I wouldn't keep my money in them for long-term. Still, if you're looking at a safer play against oil, DUG looks like a good ETF

[Crayon G.]

This article should be in Short Ideas, rather than Long Ideas. You'll make a lot more money for a long time shorting all of the above airline stocks. They're destined to fall, fall, fall for a long time.

[Think-About-It]

Although LUV is the best U.S. carrier you can't invest in it now - too expensive. If you like to buy premium companies in beaten down sectors then I'd say you should look for the best Asian airlines because they will experience good traffic growth due to China etc... over the next decade.

Anyone own a great Asian carrier or have info/opinion on which are best?