Buying 2 Airlines And An RV Stock On Oil's Weakness

| About: Southwest Airlines (LUV)
This article is now exclusive for PRO subscribers.

Summary

Oil prices have again fooled the bulls in the futures "pits" and have sold off.

That has left gold and silver struggling in their bull moves.

With the SPY pushing to new highs on a decent earnings season, stocks that benefit from dropping oil prices may come back into favor.

This article focuses on Southwest Airlines and the RV manufacturer Thor Industries as strong companies that are two potential beneficiaries of current commodities trends.

Introduction

Investing is not all about biotech!

One of the strategies that has "worked" for me over the decades is not to be too brave; playing between the 20 yard lines leaves lots of opportunity. In the case of asset allocation, that often means watching key sectors of the economy carefully without committing to them bullishly or in the other direction, but then when a breakout or breakdown occurs, jumping on a highly-correlated asset that hasn't moved yet but "should."

It's in that spirit that, in contrast to research articles on biotech stocks, I submit this for investors and traders to think about.

The argument is to look at weak oil, weak commodity plays again, but not weak interest rate plays such as housing. Here's the argument.

1. Oil is rolling over - again - but not collapsing (which is important)

(Note oil has been both down and up as I have been writing this article.)

The daily futures chart on Brent crude, which is more important globally and even in the US than WTI is, looks as though there's demand weakness (unless supply has surged, which I doubt):

The cause that's being talked about on financial media and the blogs is weak US gasoline demand. In fact, pricing on gasoline has fallen off a cliff, and it's not due to Tesla (NASDAQ:TSLA):

Of note, the bottom line showing speculative versus commercial hedger positioning shows the specs right in general. The level of positioning here is consistent with an ongoing but not completed move to lower prices. Note also that since this is a futures chart, it makes prices several years ago gradually higher than spot prices were assuming contango prevailed at the time. Meaning, gasoline prices can go even lower and not disturb the universe. That's a real 'wow' in my book after all the new automobiles pushed out the door the last few years and the supposedly strong jobs market.

Finally, a third FINVIZ chart, of WTI, shown solely for the purpose of showing how neutral the speculators were in the great oil bull market of 2001-8. Ignore prices, again, in the past years:

From 2011-4, the specs started losing consistently, as oil stopped rising but since oil was in contango, a flat price meant losses to the longs. From spring 2014 on, obviously on average the longs have lost big-time. Now we have the rollover again at a time when, again, bullish spec sentiment had been near record levels and has only retreated moderately.

What I want and expect to see when oil really bottoms is a loss of bullish enthusiasm from the speculators, especially the large specs. Why they have been so willing to send money to oil producers all these years is a puzzle, when even I saw back in Q2 2011 that the inflationary game had moved on, and turned hard bearish on oil in Q2 2014. But so it goes.

In any case, from a timing standpoint, this moderate decline in oil prices is (so far) different from the crash of 2008, which suggested a crashing economy globally. It's something to watch for, but as of today, the action in stocks and bonds suggests a stable economy, allowing investors and traders to think about economically-sensitive stocks that burn a lot of oil and gas that have lagged the record market (NYSEARCA:SPY) and could rebound if optimism returns to their sectors.

So the first message I take from all this is to look hard at energy-burning transport companies that have some sensitivity to the economy, such as airlines and perhaps truckers. I'll get to my recent buys later, but there's more on commodities to discuss first.

2. Gold and silver beginning to do what I said they would and underperform

I made it clear half a year ago or so that I did not trust the gold/silver move, and stated when crude was well in the $30s still in January and maybe in December that the money for retail speculators should be made in crude oil and not gold. Now, with crude sinking, gold and its pumped-up relative, silver, are vulnerable. If one wants to own them, especially gold, physically for the long haul, that's one thing, but just as with oil, the specs have gone wild here. Just to show silver for the apparently record level of long sentiment as far back as the chart goes:

Again, ignore the indicated prices from years ago; those are not spot prices from the time.

I give some heed to the level of bullishness, but I don't buy it. Looking at the daily chart shows gaps and support levels below the current trading price. If silver and gold sell off, hold above prior trading ranges, and do so while speculative longs vanish, I'm prepared to get bullish on them. Right now, I'm more interested in companies that benefit from lower oil prices and a non-recessionary economy.

The main message I take from this is that sell-offs in gold are good for equities; they suggest that anxieties are being quelled.

Dr. Copper and Mr. Bond are supportive of this approach

Not shown in order not to overwhelm readers with charts, but both copper prices and interest rates are "trying" to bottom here, and sentiment is consistent with that. Especially in bonds, there has been excessive bullish sentiment in the 10- and 30-year bonds, that is, too many speculators going long the bond and betting on lower interest rates (higher bond prices). In contrast, on June 30 I wrote a skeptical article on the bond bull in which I went long palladium (NYSEARCA:PALL) among other things. Basically I was trying to signal at least a tactical shift from a recessionary or curve-flattening positioning to a more aggressive and hands-off positioning. Since then, the 10-year has bumped up 10 basis points, whereas PALL is up 10% or so. I have traded out of PALL with profits and also taken profits on my UK ETF (NASDAQ:FKU).

In other words, with the SPY breaking out on a no-negative surprise Q2 earnings season, there's a lot of reason to look at laggards.

Here are the three stocks I bought either for a trade or a long term hold that pay dividends, have catalysts; and 2 of the three are very high-quality companies as well.

1. Southwest Airlines (NYSE:LUV)

The company is well into record earnings and EPS. It reports Q2 6:30 AM Thursday, so I'm taking a chance getting this article out in advance of earnings. June traffic has been reported by the company, however, so a lot of information about the quarter is already known.

It has been aggressively shrinking shares outstanding. The stock has been consolidating at a high level, within the price range first established at the very end of 2014. Southwest is one of the top 10 brands, just ahead of Fed Ex (NYSE:FDX) and right with Amazon.com (NASDAQ:AMZN) and Starbucks (NASDAQ:SBUX). That's really something for a budget airline.

The stock has some good support from indies. Thomson Reuters rates stocks on 6 criteria and gives LUV a perfect 10, one of only 194 stocks that gets that ranking. The rater Verus has backtested these rankings and optimized them; LUV gets a 9/10 by its methodology.

Fidelity aggregates ratings from a number of indie firms; LUV's aggregate ranking is 8.9 (Bullish). One of those firms, Jefferson Research, focuses on quality of earnings, operating efficiency and balance sheet, and rates LUV either its Strongest or Strong ratings for all its parameters. Value Line gives LUV an 'A' for financial strength. Its 'value line' tracks LUV's fair value at 11X 'cash flow per share.' This metric, based on estimated 2016 numbers, and which correlates to mid-year numbers, would put LUV's fair value around $64 right now, rather than its trading price around $43.

Since LUV is a US company operating almost exclusively in the US, all profits are fully taxed. This saves the issue with multinationals, which arrange very low GAAP tax rates but keep the ex-US cash out of the hands of shareholders by so doing. This means that LUV has a higher quality of earnings from the standpoint of returning cash to the owners of the business than even an icon such as J&J (NYSE:JNJ), which has brought its tax rate below 20%.

Besides all the issues with airlines, the major valuation issues I see with LUV, and which are non-trivial, are its premium to gross equipment per share. With that metric around $39 (Value Line data), LUV trading above that is above its 10-year historical range. Similarly, book value per share around $12 is very low relative to the share price.

As always in this stock market, which in some ways is at or above peak 1929 levels of valuation, nothing's perfect.

I have made a reasonable commitment to LUV, either to trade and/or to hold long term. Its many positives and large discount to the market attract me, and as stated, the softness in oil prices makes me like this as an entry time, even though I'm always cautious about the market as we enter hurricane season.

While on the airlines, I'll mention Delta (NYSE:DAL) as another airline that has a lot of support from a number of the indie analytic firms I follow; that has sold off, and is well below its 'value line.' I'm long a little DAL, but don't necessarily trust it longer term as I trust LUV. I also like LUV's domestic orientation.

The other interesting little stock I own as a play on a variety of factors is Thor Industries (NYSE:THO).

2. Thor breaks out

This little-known roll-up in the RV space has been a strong performer for many years. Seeking Alpha has had some very nice writeups of THO recently. I've read its 10-K and been all over its website. My assessment is in line with bullish commentaries on its attributes in some of these writeups, which I won't repeat.

What I would mention are two points. First, in general, this is "my" kind of company - a roll-up that carries no long term debt and plenty of working capital. Thus it makes its acquisitions for cash. It pays a dividend, has paid out a number of significant special dividends, and occasionally shrinks shares outstanding. So it's an old-fashioned gem. Plus, it's an Indiana-based company that has kept its many manufacturing facilities within the US. So it's old-fashioned financially and in other ways.

THO also has favorable demographics, as the Baby Boom generation has years of RV-buying ahead of it.

Second, THO just made a potentially important deal. It closed this month on a privately-held competitor, Jayco. This deal required long term debt which THO plans to pay down in 3 years. It expects the deal to be accretive to EPS soon. The analysts note that Jayco's margins have been perhaps half those of THO. Looking at THO on a price:sales basis and adding sales from Jayco gives me a $100 price target for a $74 stock.

On the one hand, most of us do not like to buy a stock that has just surged as THO has, especially a very boring one that's the opposite of a high-tech name or biotech with a hot technology or hot product. On the other hand, THO was a $60 stock in March 2006, and surged to $65 in March 2014. With sales and EPS at record levels, THO may have unanticipated tailwinds from relatively low gasoline prices and today's very low interest rates.

Risks and summary

The SPY is acting as if the US economy is exiting a recession or severe slowdown. Oil, however, is not acting that way, but it's a big world and the US is no longer the prime determinant of commodities prices. If instead this is just a late-cycle blip in the economy and stock traders are enthused about a merely decent earnings season that is not correctly predicting a robust expansion, then buying names such as LUV and THO opens one up to large downdrafts if a recession is on the way, or perhaps if oil spikes in a big way due to supply shortages.

From my own standpoint, these are dividend-paying names that remained (barely) profitable through the Great Recession and have long histories of growth. So I feel that in a bond-heavy portfolio, they are sensible additions even if the market and economy take a dive. I look forward to years of dividend increases and potential price appreciation from these names.

Just to be clear, these are not recommendations, especially in July with seasonal weakness ahead, so many years from the last recession, and with many sentiment indicators extended bullishly; and I'm not an investment advisor to begin with. However, certain names that have worked for years tend to work time and time again, so I mention especially LUV and THO for investors looking for high-quality companies to research with valuations that fit within previous 'normal' ranges. LUV is of course well-known; THO much less so.

Thanks for reading. I look forward to what I can learn from your comments.

Disclosure: I am/we are long LUV,DAL,THO.

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.

Additional disclosure: Not investment advice. I am not an investment advisor. Note I may trade in these stocks at any time, without notice.