Airlines Suffer Global Sell-Off - Seize The Cycle

by: Vaughn Cordle, CFA

It has not been a good year for airline investors.

The top five airlines (out of 56) are Airasia (OTCPK:AIABF), Copa (NYSE:CPA), Alaska (NYSE:ALK), Allegiant (NASDAQ:ALGT), and Westjet (OTC:WJAFF); the bottom five are SAS (OTCPK:SASDY), American (NASDAQ:AMR), Air Canada (AIDEF.PK), Jet Airways, and Republic/Frontier (RJET).

Air Canada and American Airlines are in desperate need of restructuring, especially within their domestic operations. B-scale operations makes sense for both airlines, and AMR + US Airways (LCC) equals longer-term viability and higher pay for senior employees. Young Doug Parker could really make the combination soar, but only after AMR goes through the car wash of a bankruptcy.

Frontier may not survive, and it's easy to see why Air France needs new management. Perhaps the new CEO should focus more on creating shareholder value? Alaska wins primarily because it has less competition in its markets. Southwest continues to fall in the rankings, as it transitions from a young and fast growing airline to a more mature, higher-cost, and slower-growth business.

Our research finds that the Middle Eastern airlines have too many aircraft on order given the GDP growth of the region. Turkish Airlines' CEO was touting "the customer is king" and its fast growth last year at the IATA conference in Istanbul. My presentation, at the same conference, made the case that airlines destroy economic value and shareholder wealth when they grow too fast, and that the shareholder must be the dominant stakeholder if the business is to grow and thrive over time. In other words, customer benefits above a certain and sufficient value harms the business and its ability to grow over time.

Last year, Turkish Airlines was too ambitious for its own good, and the CEO was high on the gas fumes of growth. The 58% fall in its share price should force the CEO to reflect on the wisdom of too much growth and the higher-than-necessary consumer benefits. The airline was ranked the #1 Middle Eastern airline in 2010 with the world's best business class food.

The "customer is king" theme may make sense in marketing material – however, few airlines can afford to stay at the top over the longer term. It just doesn't make sense as a corporate strategy in the airline industry. Getting the schedules right with competitive pricing (a function of competitive costs) and being on time consistently are the most important drivers of success.

Typically, when airline shares fall as dramatically as they have over the last year, opportunities to profits from the sector improves. Smart investors have learned that the cyclical airlines work best as trading vehicles.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.