Airline stocks like
may have jumped ninefold since their March lows, but after a recent pullback, airline shares are worth buying again, analysts say.
On Tuesday morning, Lehman Brothers analyst Gary Chase became the latest to join the ranks, telling investors that the near-term trading picture appears "sanguine" while boosting his fourth-quarter estimates. In short, he feels October airline revenue was better than expected, holiday bookings are strong and earnings comparisons during the first half of 2004 will be easier because of the buildup to the war in Iraq a year ago.
"Given that we expect another round of earnings surprises when the companies report earnings early next year, we expect that the shares will trade well until then," said Chase. "Airline stocks have retreated sharply in recent weeks as the market in general seems to have sobered up with regards to valuation."
In the first three months of 2003, many airline stocks, like AMR, were heading toward zero on bankruptcy fears. But after the war and SARS worries proved short-lived and summer demand for travel picked up, stocks rallied nonstop for six months. Stocks peaked at the end of September, and so AMR, which jumped 953% from March to October, has fallen nearly 18% over the last six weeks.
"As sentiment has taken a beating, airline stocks look more appealing to us," said Chase, echoing statements made by other analysts late last week. After last Thursday's close, Sam Buttrick of UBS told investors to take advantage of the recent pullback, which has been fueled by international terror fears, to buy names they missed during the first rally.
"We like to buy fourth-quarter weakness for a first-quarter recovery. We like to buy on fear. With additional short-term weakness likely on the latest international terrorism
in Turkey, we believe investors should strongly consider reentering the group," said Buttrick in his note last Friday.
Prudential Equity Group analyst Daniel Hemme also has grown more positive, issuing a note last Friday titled "The Sky Is Not Falling" that called the six-week pullback in airline stocks "a unique buying opportunity. While most analysts believe the entire industry won't return to profitability until 2005, Hemme said that revenue gains along with cost controls could lead to upside surprises in 2004.
But with the major networks still posting losses and with low-cost competition heating up in big markets, the increasingly optimistic chorus sounds some cautious notes about 2004 as well. As Chase points out, if airlines add capacity to fight a market-share battle with low-cost carriers, profits will suffer -- especially because the outlook for travel demand is unclear.
"We are concerned that 2004 may not be as easy a year as some now expect. Given the fragile financial condition of most major airlines, we question the sustainability of a wide-scale competitive retaliation, but the risk to airline stocks of all sorts, even if any spats are short-lived, is still substantial," said Chase.
Indeed, in order to cut costs and streamline operations out of its St. Louis hub, American Airlines has cut the number of flights -- allowing
to move in and pick up the lost capacity. Similarly, Southwest has announced the debut of service to Philadelphia, where
dominates a brand-new international terminal. And
will begin flying from Boston in January 2004, while
is building a new terminal in Boston as well.
Competition is fierce, and with so many low-cost carriers adding flights, Chase has upped his estimates for 2004 to call for capacity growth between 7% and 8%, up from an earlier call of 4% to 5%. While other analysts, notably Prudential's Hemme, say such capacity fears are "an overreaction," hard evidence that demand for travel has truly returned is tough to come by.
After gaining so much in just six months, airline-stock valuations had been stretched, but investors with an eye on 2005 and beyond may find some names attractive. With few upward revisions to earnings estimates over the last six weeks, the pullback in shares has cooled valuations some.
"With airlines beginning to show operational improvements, we believe weakness can be a buying opportunity for investors," said Hemme.