Airlines in Transition: The Healthiest Players

Editor's note: This was originally published on RealMoney earlier this month. With the Delta-Northwest merger back in the news, it is being republished as a bonus for TheStreet.com readers.

When crude oil was trading at $140, it was fair to wonder how many airlines might have to seek bankruptcy. If we see a fresh spike, that question will move back to the front burner.

But with oil quickly moving toward the $100 mark, investors are increasingly wondering which share prices are positioned to move up. To my mind, it is far too early to sound the all-clear on this group, because even with $100 oil and all the recent massive cost cuts, serious hurdles remain:

• Distressed consumers are becoming increasingly price-sensitive to steadily rising airfares.
• For some carriers, aging, inefficient fleets will need to be upgraded.
• The strengthening dollar is reducing demand from foreign travelers.
• Increasingly constrained corporate spenders are seeking to rein in travel expenses.

In the current environment, you want to stick with the best operators, such as Southwest Air (LUV Quote - Cramer on LUV - Stock Picks), while avoiding carriers that have old fleets and overextended route networks. AMR (AMR Quote - Cramer on AMR - Stock Picks), parent of American Airlines, comes to mind in that regard.

More aggressive investors may want to give a fresh look at JetBlue (JBLU Quote - Cramer on JBLU - Stock Picks), which has established very strong brand equity and a low-cost structure, even though the carrier is now experiencing significant growing pains.

Showing Fliers Some LUV

In a perverse way, Southwest would have greatly benefited from high oil prices. That's because the carrier has the financial muscle to expand into markets that others are fleeing. That may still happen, but even at $100 oil, Southwest is a "safe" way to play the sector's upside ("safe" being a relative term when it comes to the airline industry).

As was noted before, Southwest aggressively hedged fuel costs and has been able to make money on routes where others could not. (The company has hedged 70% of its fuel requirements at $50 per barrel for 2008, and 55% at $51 in 2009.) Those hedges will steadily erode over the next two years, but Southwest still has the second-lowest costs (in terms of seat miles) in the industry after Airtran (AAI Quote - Cramer on AAI - Stock Picks).

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