Should Airline Stocks Be Bought?
Ted Reed
06/10/08 - 09:28 AM EDT
CHARLOTTE, N.C. -- Last week's increase in oil prices put a scare in the airline industry and raised new questions about buying the shares of publicly traded carriers.
Because share prices in the notoriously cyclical industry have scraped along at the bottom of the cycle since April, some experts sense a buying opportunity. On the other hand, share prices are linked inexorably to oil prices, which have gyrated wildly in recent days.
CreditSights analyst Roger King recommends investors continue to avoid the sector. "To play a lower oil price scenario, just short the commodity," he wrote recently. "Don't go long airlines and inherit all the idiosyncratic industry issues."
Lehman Brothers analyst Gary Chase wrote in a recent research report that "bankruptcy risk is significant" for the entire sector. Still, "for that very reason, however, we believe significant changes must, and ultimately will, happen."
Chase says he sees "plenty of risks to this call," most notably the chance of a sharp spike in oil prices. He wrote the report with oil prices around $125 a barrel.
"What airlines should be doing is betting on the worst," said Joe Leonard, recently retired as chairman of
AirTran (AAI Quote), in a recent interview. "That's generally what works out in the airline business."
Leonard says a capacity cut of 15% to 20% is needed, which seems to be where the industry is headed.
Capacity reductions offer two substantial benefits: more control over pricing and removal of aircraft that aren't fuel-efficient. And say this for airlines -- carriers rarely hesitate to follow a competitor's lead.
Last week,
UAL's (UAUA Quote) United said it will cut 17% to 18% from mainline domestic capacity by 2009, while
Continental (CAL Quote) said it will decrease capacity by 11%.
Earlier,
AMR's (AMR Quote) American and
Delta(DAL Quote) announced 10% cuts.
Low-cost carriers, meanwhile, will stop growing or slow growth. In the fourth quarter, for instance,
JetBlue(JBLU Quote) will have the first quarter of negative growth in its history. Only
Southwest(LUV Quote) plans to expand in the fourth quarter, at a rate of about 1.4%.
For the entire industry, the Air Transport Association projects capacity will decline by 2.8% this year, with cuts between 6.6% and 7% in September, October and November.
CreditSights' King cautions that because most capacity drops won't take place until after the summer travel season, "investors won't know [their] financial effects until the end of January, seven months from now."
Meanwhile, shares in all carriers trade near historically low levels. The Amex Airline Index, which hit its all-time low of 17.87 in May, was at 18.92 Monday. Until this year, the nadir was 25.83 in March 2003.
The prices of five years ago reflected the industry's initial inability to cope with the economic slowdown that accompanied the Sept. 11 attacks. A series of bankruptcies began in 2002, when
US Airways(LCC Quote) filed. It emerged in 2003, only to declare insolvency again in 2004. At one point, four of the six legacy carriers operated under bankruptcy protection.
"This is a pretty scary period we are going into right now, much worse than 9/11," Leonard says. "That was an event where we knew the outcome, assuming there wasn't a second event. This is a continuum."
Lehman's Chase agrees the situation is worse this time. "The industry's better financial position, along with government aid and other factors, in the post 9/11 period allowed for a slower restructuring and adjustment process than we now envision," he writes.
Chase recommends Delta, United, JetBlue and
Northwest(NWA Quote). Lehman Brothers holds at least 1% of the shares of each company, and trades regularly in all of them.
Meanwhile, FTN Midwest Securities analyst Mike Derchin says "the shakeout caused by $125 oil is a Darwinian struggle of survival of the fittest." This year, a half dozen smaller carriers have shut down, he notes, and the industry could lose about $4 billion. But "2009 is forecast to be a turnaround year, with the airlines rebounding," he says.
Derchin recommends Southwest, AirTran and
Alaska(ALK Quote).
