Airline Stocks Fly Through the Downturn - TheStreet

CHARLOTTE, N.C. -- Looking for a safe haven in today's jittery stock market? Try the airlines.

The sector rose sharply Tuesday, with the Amex Airline Index up 11.5%. On Monday, as the market plunged, the index was flat, but shares in several carriers rose significantly.

UAL

(UAUA)

has been a leader this week, gaining 7% on Monday and 13% on Tuesday.

AMR

(AMR)

gained 4% on Monday and 15% on Tuesday.

Delta

(DAL) - Get Report

jumped 23% on Tuesday.

Sure, most of the advance is due to tumbling oil prices, but that's not the whole story. In fact, for weeks, falling fuel prices may have masked what's really going on in the airline industry, which is that demand has remained strong, despite a slowing economy, and widespread capacity discipline shows no sign of diminishing.

While the future may include a sharp downturn in traffic for U.S. carriers, that has not been the case so far. In fact, although airline share prices have doubled since mid-July, in line with oil price declines, the other positives have not been priced in, several airline analysts say.

Last week, the news was all good.

Continental

(CAL) - Get Report

said domestic bookings for the next six weeks are running about 2 points higher than last year, even as domestic capacity is falling. It's down 9% this month, when the carrier expects "substantially higher" mainline domestic yields.

JetBlue

(JBLU) - Get Report

also says bookings are strong. At an analyst meeting last week, executives "were saying they haven't seen demand this strong in a recessionary environment in the last 20 or 30 years," says FTN Midwest Securities analyst Mike Derchin.

Despite falling fuel prices,

AirTran

(AAI)

says it has no plans to scale back a planned capacity reduction of 7% to 8% this year and 4% to 8% next year. For years, AirTran has been among the industry's growth leaders.

"We have already made commitments to sell airplanes, and that is permanent," said CFO Arne Haak, in an interview. "We have deferred deliveries with

Boeing

(BA) - Get Report

, and that is permanent. And I think there is likely to be capacity discipline in our industry for some time now."

The trends add credence to the July statement by Doug Parker, CEO of

US Airways

(LCC)

, that "What's already being done

in capacity reduction may be enough to get the industry profitable in 2009."

Even 2008, while bad, doesn't look quite as dire as it recently did. Last week, the Air Transport Association said industry losses this year should total between $7 billion and $9 billion. That's a reduction from the $7 billion to $13 billion it had predicted earlier.

Derchin says that after seeing Continental's report to investors last week, he now projects a 2009 profit for the carrier of $2.14 a share. He had been predicting a loss of 31 cents.

His other favorites include AirTran, American and

Southwest

(LUV) - Get Report

.

"AirTran is the biggest bargain out there," Derchin says. Investors have been scared off due to fears that Delta will try to undercut AirTran's pricing in Atlanta, he says, but that is unlikely given Delta's new focus on global growth.

As for American, investors seem to fear a pilot strike, but even if one is to occur, "it is two years off and it will be short because it will lead quickly to binding arbitration," Derchin believes. And he says Southwest shares could double in three years, due to downsizing by competitors, improved technologies, and differentiation because it charges few fees.

JP Morgan analyst Jamie Baker also says airline shares remain undervalued, with the market failing to recognize that, since the first quarter, "record capacity has been shed, liquidity has strengthened and

annual ancillary industry revenue has improved by an estimated $3 billion." He too predicts a 2009 industry profit.

In a report this week, Avondale Partners analyst Bob McAdoo said this may be "the first time in history where all carriers are substantially and simultaneously reducing capacity." He said most capacity plans were drawn up for $130 oil, far above its current level, and "most airlines are now positioned to thrive."

Yet the real benefit for investors will come after "a decoupling of share prices from oil prices," McAdoo wrote, because the oil price decline is only the first chapter in the story.

To be sure, history reminds us that since the first flight by the Wright Brothers, the airline industry has failed to turn a profit.

AirTran's Haak notes the projected $7 billion 2008 industry loss would wipe out the profits the industry earned in 2006 and 2007, which followed five consecutive years of losses. "We just had a couple of good years as an industry," he says. "Then we were hit by oil, and then we got a break on oil, and now we have to see how the economy plays out."