2013: The Year Of The Airlines?

Includes: AAL, BA, DAL, UAL
by: Teresa Dawn

2012 was a breakout year for airlines as industry wide capacity cuts finally began to pay dividends to shareholders. The bulk of the industry's largest companies all outperformed both the S&P 500 and the transportation sector. Now, the industry has once again gotten off to a good start in 2013, and there are many reasons to believe that 2013 will once again be a great year.

A lot has changed in the airline industry since hurricane Sandy. The hurricane created a major impact on the airlines, with over 18,000 flights canceled. At the time, this was considered to be a major negative for the industry, and investors were concerned that earnings would pay the price. Yet major airline companies are sitting close to 52-week highs and the Dow transports are at all-time highs. Therefore, might it be time to buy?

The airline industry is one of the most covered in the market, as far as research and data to gauge the overall strength of the industry. In my opinion, there are three pieces of data that indicate a strong year for the airlines: The IATA profit forecast, the ARCA Airline Index (XAL), and the countless upgrades that are meaningful to retail and institutional investors.

Yesterday, I think Barclays said it best, "airline stocks could rise 20% on a mix of higher fares and lower fuel prices." These are the catalysts that have investors buying airline stocks. In 2013 it looks as though investors are bullish, as the XAL (Airline Index) is up 10% in the first few weeks of the year. Further, the IATA has raised its profit forecast, from $4.1 billion to $6.7 billion due to the catalysts that Barclays mentioned. Therefore, fundamentals are improving and outlooks are rising as a result.

With the industry, as a whole, seeing mass improvements, where is it that investors should look to buy? According to the WSJ's Middle Seat blog, the Delta (NYSE:DAL) flying experience has seen vast improvements from bad to good; yet both United Continental (NYSE:UAL) and American Airlines have continued to see a declining score. Therefore, does this mean that Delta may be the stock to own in 2013, with strong industry performance and a favorable consumer preference?

Delta Air Lines might very well be the best in the industry for a long-term investment. The company has increased in value by almost 60% in the last year, including a 23% rise in the last month following encouraging data from the industry. The company currently trades with a market cap of $11.70 billion but has an enterprise value of $21.66 billion and trades at just 5.50 times next year's earnings. The company has operating cash flow of more than $3 billion and has been very successful at improving its efficiency following a restructure in capacity. Therefore, Delta is without question a great and safe choice as a long-term investment to capitalize on the growth of this industry.

While Delta is a great choice when it comes to value and safety, 2013 could also be the year of US Airways (LCC) if in fact it merges with American Airlines. Aside from an improved industry, the big news of 2012 was the bankruptcy of American Airlines, and the discussion of which company would acquire its assets in bankruptcy. At first, Delta and United Continental were the focus of speculation, but after concerns that regulators may not approve the deal and serious talks with US Airways, the talks shifted, and US Airways rallied.

Currently, US Airways is about one-third the size of either Delta or United Continental. However, US Airways has been working on a deal with American Airlines since mid-November to acquire the bankrupt airline. The biggest concern of this acquisition was a labor deal with American Airline pilots, but earlier this month it was reported that the deal is "close". If this deal is finalized and finished, US Airways could be worth more than $8 billion. The company currently has a market cap of $2.35 billion after a 147% return during the last year. Therefore, a lot of upside exists if in fact the deal closes, but downside might also occur if the deal does not close. As a result, US Airways is a good speculative investment in the space for those investors seeking more than safety and security.

The airline industry as a whole is loaded with opportunity. There are several companies in the space with attractive valuations and bullish forecasts that could very well rally higher into 2013. In fact, looking at the industry as a whole, I think the only sizable risk is with Boeing (NYSE:BA). Boeing's problems have come to the forefront of American and global news and there is some risk that its 787 concerns could spark fear into those who travel for leisure. This will be an interesting development to follow, and could create temporary weakness, but overall the positives look to be too much, and the valuations too significant. As a result, I can't see a scenario where airlines don't continue to trade higher in 2013, regardless of which stock you believe to be the best.

Disclosure: I am long DAL. 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.

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