Airlines Taxi Toward Profitability

A rising economic tide should carry the airline industry toward profitability in 2004, making stocks in the sector an attractive bet while the major carriers take on their low-cost competitors in earnest.

In 2003, the airline sector was a hot place to be after the world's largest carrier, American Airlines parent AMR (AMR Quote), averted bankruptcy and the war in Iraq proved short-lived. The Amex Airline index gained 123% from mid-March through early December, led by a sevenfold increase in AMR.

While 2004 may not promise such massive gains, many economists, analysts and consultants agree that an expanding economy will boost business travel and allow the sector to outperform the S&P 500. A recent report from investment adviser Palladian Research recommended that fund managers focus heavily on the airline sector in 2004, now that the industry has laid a foundation for improving business fundamentals by cutting jobs, eliminating expenses and streamlining operations.

"Looking into 2004, any one of the airlines could do well. If you look at air transportation relative to GDP, it's down to historical lows. If you market-weight or overweight the airlines, it doesn't necessarily matter who wins or loses, because you'll see good moves in these stocks," said Eric Sites, equity analyst at Palladian and author of the report. (Palladian has no banking relationships in the airline industry.)

Adam Sacks, an economist at consulting firm Global Insight, agrees that airlines are poised to take advantage of the improving economy. "Traditionally, passenger aviation has grown at a faster clip than GDP, but by that token it's more volatile on the downside, as we've seen," he said. "If you see that GDP is going [down] to 1%, the airline passenger services tend to dip more dramatically. When the economy is doing well, passenger aviation grows at a much faster clip."