By Tim Begany
I'm going to do something I thought I'd never do -- recommend an airline stock. Like many investors, I've never liked airline stocks because they're ridiculously volatile and notoriously easy to lose money on.
Take the nation's fifth largest airline, U.S. Airways Group (LCC). U.S. Airways has gone bankrupt twice in the past decade. Yes, the stock has done nicely in the near term, returning almost 40% a year during the three-year period ended Oct. 18, 2012. But the trailing five-year return is a dismal negative 15.8%. The company's main rivals have been awful longer-term investments, too, as the table below shows.
Notably, the table doesn't include one well-known company -- American Airlines Inc., which filed for bankruptcy in November of last year. Currently, the stock only trades over the counter for around 37 cents a share. It's not something you'd buy anyway, since bankruptcy usually renders a company's existing common shares worthless. New shares will be issued later if the company survives bankruptcy.
As always, the main risk with airline stocks is intense competition resulting in wafer-thin profit margins. Indeed, the industry's combined net profit margin is a pitiful 2.8%. Net margins for the individual companies in the table above are pretty much the same, ranging from just 2% to 3.3%.
But what if I told you I found an airline that's not only profitable, but is more than five times more profitable than the typical industry player, with net margins averaging an astounding 15.5% during the past nine years? Would that grab your attention?
Well, the uncommon profitability of the Panama City-based airline company Copa Holdings SA (CPA) sure grabbed my attention. It also made me want to know more about how Copa can do so well in an industry where declaring bankruptcy has actually become a commonplace business strategy.
A big reason is the company's operating territory -- 295 daily flights to 59 destinations in 28 countries of North, Central, and South America, and the Caribbean. Basically, Copa is in a fast-growth region where the air travel industry is still on the rise, not saturated like in the United States, and direct competitors are much fewer in number. Indeed, no single competitor serves all the same routes as Copa, so it can often charge a premium. Meanwhile, U.S. airlines struggle to get by competing on prices in a crowded field with a reputation for terrible service.
Copa has a reputation for being particularly convenient for business travelers in a hurry because the company can treat connecting passengers like they're on a domestic flight, even if they're passing through one or more countries. This means business travelers don't have to spend extra time getting visas or going through customs (unless they leave the airport).
The company has also been posting quick growth in key measures such as available seat miles (ASM) -- aircraft seating capacity multiplied by the number of miles the seats are flown -- and revenue passenger miles (RPM), the number of miles flown by paying passengers. These two measures are key to tell industry observers of how much business an airline is bringing. For instance, ASM in September was about 1.4 billion, a 27% increase from 1.1 billion in September 2011. Copa posted the same 27% year-over-year rate of growth in RPM, which climbed to 1.05 billion in September.
I also I like the fact that Copa is in expansion mode, with plans to add 10 more aircraft to its current fleet of 83 passenger and cargo jets (mainly Boeing 737s) by the end of 2012.
Risks to Consider
I certainly don't want to make it sound like Copa has no competition, because it has plenty. Mexicana Airlines, based out of Mexico City, for example, offers significant competition on routes between Latin America and North and South America.
If you've been avoiding airline stocks because of the high risk, then consider taking a look at Copa Holdings. Along with the reasons I've already mentioned above, Copa is an excellent investment because of the potential for attractive earnings, which analysts predict could double into the $13-a-share range in three to five years.
Assuming Copa's price-to-earnings (P/E) ratio remains in line with the historic average of 10, you could be looking at a 45% gain in the price of the stock to $130 a share (P/E of 10 x projected earnings per share of $13 = $130) from about $89.50 now. The stock's decent 2.3% dividend yield helps sweeten the pot a bit as well.
Disclosure: Tim Begany does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.