Why I'm Bearish On Airline Stocks

Includes: AAL, DAL, UAL
by: Benjamin Goldman

Since AMR Corporation (AMR) declared bankruptcy, its three main competitors, Delta Air Lines (NYSE:DAL), United Continental Holdings (NYSE:UAL) and US Airways Group (LCC), have all performed very well with stock price increases of 7.54 percent, 17.96 percent, and 21.55 percent at the close of December 13th, respectively. It seems like the market believes AMR's bankruptcy will cause its competitors to garner more business. However, I believe that AMR's struggles may be a precursor to what the futures of Delta, United Continental, and US Airways Group hold.

An argument for why AMR's competitors won't follow into eventual bankruptcy is that they are profitable. AMR has not had a profitable year since 2007 while Delta, United Continental and US Airways were profitable in both 2010 and are expected to stay profitable in 2011. In addition, all 3 are expected to have substantially increased earnings in 2012. However, airline earnings can change on a dime and if jet fuel prices continue to trend higher (despite hedging), the entire airline industry can be in the red next year.

I believe that all four of these airlines will exist in some form for the long term. The major concern is whether their current stocks will reach absolute zero or not. Airlines are leveraged to the hilt. Delta, United Continental and US Airways have total debt to equity of 17.00, 8.76, and 52.38, respectively. If these companies undergo another few years of losses, their asset values will drop below their debt and bankruptcy will be inevitable.

The trend in the airline industry is for airline bankruptcies to come in clusters followed by extensive mergers and aquisitions to achieve profits on economies of scale. I believe that airlines will become better off once their fleets become more fuel efficient with new carbon fiber planes from Boeing (NYSE:BA) and EADS. However, I can picture airlines heavily restructuring their companies so that they can better adjust to their changing industry. Airlines are tough investments because the industry is frequently in the red and they tend to get a very small piece of the aerospace pie when compared to other industry players like airplane manufacturers. Theses stocks can easily drop 90 percent in a year despite already being undervalued, and I believe there are much safer investments out there that have much higher expected returns. I believe that in the next three months, Delta, United Continental and US Airways will all gravitate back to their prices before the AMR bankruptcy and will have a lot more downside potential from there.

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

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