Justin Lahart

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Some Airline Stocks Worth a Flier

Justin Lahart

First, one must separate the wheat from the chaff. Judging by their plummeting stock prices, mounting losses and horrendous debt loads, the chaff includes US Airways (U Quote) and America West (AWA Quote). The wheat, by all accounts, is Southwest Airlines (LUV Quote), by virtue of its low costs and unimposing debt.

Yet a bet on Southwest seems little wiser than one on US Airways or America West, considering how ubiquitous the buy-Southwest argument has become. Its stock has dropped just 15% since trading resumed, easily outpacing the average airline stock and suggesting many airline investors are already riding that horse.

So the key is to find the wheat that's being treated like chaff. Two analysts say the companies that could thrive after the industrywide shakeout include Continental Airlines (CAL Quote) and AMR (AMR Quote), both of which are down substantially but offer strong value fundamentally.

"Some folks are taking the view that they'll buy the safest airline stocks and that's it," says Salomon Smith Barney's Brian Harris. "I want to discern which airlines have the most viable long-term business models and which ones are the most oversold." With the government's aid package, he says, the focus has shifted from liquidity concerns to basic fundamentals. If an airline is perceived as fundamentally sound, the government will provide the cash.

Harris believes the best opportunity is Continental, whose stock, down 60%, has fallen nearly as hard as US Airways. (Salomon has done no recent underwriting for the company.) Continental's labor costs and relations are better than its peers, and it has the youngest fleet in the industry. Its major hubs are in large metropolitan markets, which gives it flexibility in cutting capacity. When business declines in a large hub, you can use smaller planes and schedule fewer flights. At a smaller hub, this is much harder. Investors, thinks Harris, have lost sight of this, and instead have focused too heavily on Continental's high debt-to-capital ratio.

UBS Warburg's Sam Buttrick is taking a similar tack. There are, he says, "unprecedented return opportunities for those carriers that survive."

Buttrick recommends that investors look at AMR, parent of American and TWA, and, if they have the nerve to do it, Northwest Airlines (NWAC Quote). (UBS has done no recent underwriting for any of the major carriers.)

"In effect, the equity risk premium for holding airline stocks has soared to an unprecedented level," the analyst says. "Over time, the risk premium will return to more normal levels."

It is one thing for Wall Street to advise investors to buy the airlines, however, and another thing altogether to do so -- even when you know that in a year or two you may well be kicking yourself for not putting any chips down. James Fessel, an analyst with PNC Advisors, which has more than $60 billion in assets under management, says his firm had no exposure to the air carriers going into the crisis and for now is sticking to the sidelines when it comes to the stocks.

"Overall, you want to stay as far away from capital-intensive companies as possible during a sharp economic slowdown," he says. "A swing in sales in the wrong direction leads to billions of dollars in losses." And he goes on to say that the only airline he'd consider investing in right now is -- you guessed it -- Southwest.