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Published: July 1, 2010
During the past few years, airlines staged
a remarkable comeback. The major legacy carriers such as
Continental (NYSE: CAL), Delta (NYSE: DAL), AMR's
(NYSE: AMR) American Airlines and UAL's (Nasdaq: UAUA)
United took a lot of planes out of service, cut major
cost-saving labor agreements, and benefited from sharply lower
fuel prices. Large losses became large profits, helping the
AMEX Airline Index (AMEX: XAL) to rise from around $12 in
March 2009 to $40 in mid-June.
Yet in recent weeks, the
index has headed south, falling for eight straight sessions
before a modest
uptick on Wednesday. The sector saw some life when Delta's
CEO Richard Anderson spoke bullishly earlier in the day at his
company's annual meeting. "The recession was a 'terrible cycle'
that has wreaked havoc on balance sheets and stocks," he said,
"but we are now moving into an up cycle."
That's certainly the case, by any measure. Ticket prices are
higher, leading to +20% year-over-year gains in passenger
revenue per average seat mile (known by the unwieldy industry
moniker PRASM), fuel costs remain manageable, and the European
volcano scare has abated, boosting air traffic on the Continent
to pre-recession levels.
Firming prices and low costs add up to
money in the bank: Continental, Delta, AMR and UAL should see
profits rise sharply this year, posting their best gains in
years. Continental for example, has a decent shot of earning
even more than the $3.74 a share bagged in 2007, a high point
for the last decade.
But clouds loom on the horizon. For starters, management talked
labor into major concessions a few years ago, and many of those
contracts are coming up for re-negotiation. You can bet that
labor will be a lot less cooperative this time around.
In addition, even as European air travel has posted a solid
rebound, further economic weakness on the Continent could spell
trouble. Remember that planes have the same expenses whether
they are half-full or completely full. As a rule of thumb, a
plane needs to be roughly two-third filled to be operating at
break-even. Right now, the load factor (which is the percentage
of seats filled) is inching toward 80%. It helps that there are
roughly 15% fewer planes flying than in 2008. The major carriers
will begin releasing their latest load factors and PRASMs in
coming days (starting with Continental after the bell on
Thursday), and share prices may move quickly up or down on that
data.
Finally, the industry is always one step away from a
profit-sapping spike in oil prices or a terrorism-related slump
in air travel. Neither of those factors is of concern at the
moment, but they can arrive without warning.
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As
the accompanying
table shows, these
stocks are dirt
cheap, with several
of them trading for
less than five times
projected 2011
earnings. Those
price-to-earnings
ratio (P/E)
multiples are based
on consensus
estimates. And
analysts are
assuming very strong
profit growth in
2011. But should
they? After all,
labor costs are set
to rise, and it may
be awhile before the
global economy is
truly healthy. So
further volume and
pricing gains may be
hard to achieve.
Action to Take
--> It
increasingly looks
as if 2011 profit
estimates will need
to come down. So the
industry P/E ratios
are probably not as
low as they appear
in our table. But
the kind of earnings
power that analysts
expect to see in
2011 could still
well happen in 2012
or 2013. So shares
are indeed quite
cheap if you have
that kind of time
horizon.
It's worth noting
that Southwest
Air (NYSE: LUV)
is not as exposed to
rising labor costs,
as it inked more
recent labor
contracts. So
analysts' estimates
for LUV are not
likely to come under
the same pressure.
In addition, this is
the first time in
its history that
JetBlue (Nasdaq:
JBLU) has traded
for less than ten
times projected
earnings. JetBlue
also has a better
labor cost profile
than the big
carriers. These two
low-cost carriers
are also less
exposed to the
possibly turbulent
European air market,
making them the
safer plays, even if
they sport higher
P/E ratios than the
larger legacy
carriers.
-- David Sterman
Staff Writer
StreetAuthority |
