Fidelity Pares Airline Holdings

The fund firm appears to be taking some profits ahead of what should be uplifting results for the sector.
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As the airline industry prepares to kick off its third-quarter earnings season, expectations are high -- so high that Fidelity Investments recently unloaded large clumps of its holdings in the sector.

Fidelity won't discuss its strategies, but on the surface, the mutual funds giant appears to be making a cyclicality call.

Regulatory documents filed with the

Securities and Exchange Commission

last week show that Fidelity has reduced its stakes in

AMR

(AMR)

,

UAL

(UAUA)

and

US Airways

(LCC)

. The firm cut its AMR and UAL stakes to 5% from 13% and sliced its US Airways interest to 9.9% from 15%.

"It's always difficult to get inside of money managers' heads, but the airline industry is notorious for its cycles," said Morningstar airlines analyst Brian Nelson.

"These are not buy-and-hold stocks," he continued. "They have been perennial value destroyers since deregulation in 1978. The classic approach from the money management side is to sell cyclicals when things are looking really good and to buy when things are looking bad."

Looking at it that way, the recent drop in oil prices combined with a series of positive comments by airline analysts provides plenty of reasons to sell.

Although several carriers have identified softening revenue trends, partially as a result of heightened security following the foiled terrorist plot in the U.K., airlines are benefiting from reduced fuel prices.

Calyon Securities analyst Ray Neidl said this week that he expects the industry to report profits of $1.3 billion in the third quarter and $1.1 billion for the full year. In 2007, he expects a $6.1 billion profit. That would eclipse the industry record of $5.4 billion, set in 1999, according to the Air Transport Association.

Meanwhile, Merrill Lynch analyst Mike Linenberg said he believes the industry will report pretax profits of $1.2 billion in the third quarter. While that would be a decline from the June quarter's $1.8 billion, "it would represent the second consecutive quarter of industry profitability, something we haven't seen since 2000," Linenberg wrote in a recent report.

He said that free cash flows will be unusually strong, particularly at American, the carrier owned by AMR, and United, the airline operated by UAL.

JPMorgan analyst Jamie Baker initiated coverage of UAL last week with an overweight rating, although he issued a lukewarm endorsement of the company. "

UAL looks much improved, though largely indiscernible from its peer group -- except on the basis of price," he wrote.

Baker forecast record profits for UAL next year, saying it will benefit from limited demands on its cash flow because it has no cash pension funding due, limited debt maturities and few near-term aircraft deliveries.

JPMorgan has a business relationship with UAL that, in the last 12 months, has included acting as an investment banker.