Put Airline Stocks on Your Radar Screen

It's no secret that I've liked the airline group for a few months. The sector represents the antithesis of the technology and telecommunication momentum stocks that were destined to change the world in the last cycle.

The truth is, of course, that the world is changing for the better because of the technology revolution. But change and impact don't translate into investment gains when excessive capital is deployed. Astute investors look at the flip side of the capital-flows coin and find sectors where the competitive landscape is more benign, areas that have been ignored for the past few years.

Without the stress of excess capacity, I continue to like the mid-cap stocks that I have recommended in sectors such as chemicals, auto parts, retail and apparel, among others -- and airlines, of course. Here is the performance to date of the airline stocks I've highlighted. All three have outperformed the broader market by an average of 6.24%.

Flying High All three airline picks have outpaced the S&P 500 in the same time period.
Stock	Date of Column	Symbol	Cost	7/11 Close	Gain	Performance of S&P 500	Outperformance
UAL	12/28/00	UAL:NYSE	$35.88	$34.56	-3.68%	-11.48%	7.80%
Delta Air Lines	3/30/01	DAL:NYSE	$39.50	$43.82	10.94%	1.50%	9.44%
Northwest Airlines	4/17/01	NWAC:Nasdaq	$23.50	$23.66	0.68%	-0.80%	1.48%
Avg. Return						2.65%
Avg. Outperformance						6.24%
Source: Alsin Capital Management

I made it clear in a recent column that I made a mistake on UAL (UAL Quote), that I overreached for this ineptly managed company. With my Top-10 Turnarounds up 28% for the year, I'm keeping UAL on the books for the balance of the year, though I only own a tiny position. A much better pick than UAL is Continental Airlines (CAL Quote), which I believe has the best management in the industry.

Recognizing Value

Choosing a stock like Continental would have been laughed at during the heady tech times of the last bull market. But investors are increasingly waking up to the idea of solid, boring companies, like Continental, that are undervalued relative to their prospects. I know current business conditions are awful at Continental, with no improvement in sight, but I'm not picking this stock based on current-year prospects anyway.

The Cycle of Continental Over the past five years, it has had its ups and downs, but could be in a trough now.

Let's assume -- although the business world is obviously not this orderly -- that out of every four years or so, the airlines have a couple of decent years, as well as a peak year and a trough year. This is the trough year, in my opinion, so the numbers posted by Continental are currently of limited utility for the prospective investor. And what Continental can earn in a peak year is not relevant, either.

It's best to base an evaluation of Continental on how it will perform in a normal year. But here's where it gets tricky -- and potentially very profitable -- for a new investor. While I think Continental can easily earn $10 a share in a better environment, the company's recent announcement that it will spin off part of its ExpressJet subsidiary to Continental shareholders provides a nice kicker for buyers of Continental stock.

Commuter airlines, such as ExpressJet, sell at rich multiples because of their high margins and less cyclical revenue stream. Comparable commuter SkyWest (SKYW Quote) currently sells for 3 times revenue. Even if ExpressJet receives half of that valuation, the shares received by Continental shareholders next year could represent a 50% windfall for them, assuming Continental shares remain constant. Though Continental will no longer have ExpressJet to contribute to sales and earnings (about 8% of sales), an improved business backdrop for Continental could make up the difference, and more.