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Airlines Finding Ways to Prosper

Despite record oil prices and the economy slowing, some see bright prospects.
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That memo about the slowing economy still hasn't reached the airline industry.

In fact, two veteran airline analysts say the investment outlook for the industry is as good as they have ever seen.

Booking trends for the current quarter are positive, four of the six largest airlines reported last week. Three of the four posted third-quarter unit revenue growth in the 5% range, and expectations are high for

United

(UAUA)

and

US Airways

(LCC)

, which report this week.

Sure, fuel prices are high. But as

Continental

(CAL) - Get Report

CEO Larry Kellner said last week: "I never thought we'd be using the terms 'record oil' and 'record operating results' in the same quarter."

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By and large, legacy airlines continue to limit capacity growth and to raise fares as oil prices warrant. A positive here, JP Morgan analyst Jamie Baker wrote in a research report, is that

Southwest

(LUV) - Get Report

"continues to migrate from its traditional role as an industry spoiler to something far more disciplined."

Southwest has raised its fares five times this year, Baker says -- and that gives full-priced airlines more room to keep prices up.

JP Morgan has a financial relationship with Southwest that includes having recently provided investment banking services.

International growth remains strong, and last month, the Transportation Department handed each of the six legacy carriers a new route to China, with service to begin in 2008 for some and in 2009 for the others. (The 2009 awards were tentative.) Because the market is so underserved, each China route is worth about $200 million in new revenue, experts say.

Both Baker and Bob McAdoo of Avondale Partners like the outlook. Baker wrote recently that "legacy sector risk/reward ranks among the most favorable we've ever seen."

McAdoo, meanwhile, notes that earnings for the six traditional carriers improved by more than $1 billion in the first six months of this year.

"Conditions going forward are likely the most favorable we have seen in the last 20 years," he wrote. "The airline industry is poised for improving results through 2008."

McAdoo says Continental and US Airways are his favorites. He notes that risks in the sector, which has recorded a loss since the Wright Brothers first flew, are high, including fuel prices, fluctuations in the economy and the possibility of a terrorist attack.

So far, investors seem to have focused on the risks. The

Amex Airline Index

hit a three-year high of 66.92 in January. It was trading Monday at 45.48, and is down about 22% for the year.