When I was checking my portfolio this morning, almost every stock I own was in green. It was nice to see so many greens even though it's due to quantitative easing more than anything else. Then I noticed one stock sticking out in my portfolio. This is a company which I believe to be undervalued; however, it was still falling while everything else was on the rise. The company I am talking about is US Airways (LCC). At first I thought, "what kind of drama are they going through with American Airlines (AAMRQ.PK) this time?" I checked the news and didn't find anything.
Next, I checked the airlines I didn't own, such as Delta Airlines (NYSE:DAL) and Southwest Airlines (NYSE:LUV). Both companies have seen their stock price go down in the last two days even though the decline in the market caps of these two companies wasn't as bad as the US Airways. Then I realized what was going on. Basically, owning an airline company is like shorting oil, and I was shorting oil by owning the US Airlines. As the quantitative easing drives oil prices higher, the airline stocks will suffer.
In the last couple months, the airlines increased their ticket prices more than once. Once a leading airliner raises its prices, all the other airlines jump on the bandwagon and use this opportunity to justify the price increase. If everyone increases their prices at once, no one loses competitive advantage. Apparently, while many airline companies are enjoying all-time high profits, they still feel the need to raise their prices to pass more and more costs on to the consumers.
Different airline companies are coming up with different solutions for the high price of oil. For example, Delta Airlines is buying up refineries to produce its own fuel. US Airways engages in hedging. Fuel makes a large percentage of expenses for the airline companies, and these companies want to get creative about how to deal with the rising fuel costs. Another big cost for the airlines is the employee contracts. Most employees working for the big airlines are union workers, and they are tough to deal with for these companies.
What happens to airline companies if the quantitative easing works as it is intended? If quantitative easing has the most desired effect on the market, the unemployment rate will come down, demand for air travel will increase, and the revenues for the airliners will increase. In addition, as the market moves up, these stocks will move up too. On the other hand, the airliners will have to deal with higher costs such as fuel, workers and other materials. If the quantitative easing doesn't have the desired effect on the economy, the increase in the fuel prices will be temporary and the air travel is more likely to stabilize than to increase rapidly.
In either case, I don't see much trouble for the airline companies. I don't think the oil prices will go much higher than they are today. Even with quantitative easing, I see oil prices nearly peaking unless the demand for fuel increases substantially all over the world. At most, the quantitative easing will increase the demand in the US, but it won't have much effect on the demand in the other parts of the world such as Europe and Asia. Unless the other big central banks also issue their own version of QE, I don't see fuel prices going up too much from where they are now. Besides, most speculators were already expecting a QE and the oil prices were already heading up weeks before the QE announcement.
I think the current panicky behavior of investors of the airline companies is not justified. While the market is rallying, the big airlines should be rallying too. Many large airlines, such as Delta and US Airways, are enjoying the most profitable era of their history and they are trading at very low current and future multiples.
Because airline companies are not stable in the long run, I don't like the idea of investing in an airline company for more than 2-3 years; however, in the short and medium-term, there are many airline companies that present a great value at the moment. This is one of the most oversold industries we have today.
Disclosure: I am long LCC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.