Airline Rally Fails to Quiet Table-Pounders

The concerns about the viability of many major and second-tier airlines can't be minimized. Serious questions remain about when business travel and pricing will pick up, and analysts aren't necessarily betting on dramatically improved fundamentals for the carriers anytime soon.

Investors, however, shouldn't get distracted with the negatives, a group of bullish analysts contend. Instead, these experts are figuring, things will simply continue to be less bad over time, making the airlines a worthy investment. So far, that bet has paid off. Airline stocks have zoomed 65% on average from their September lows, and a host of analysts believe it's not too late to join the rally they think will keep building.

"The group has bounced back, but it's still depressed relative to other cyclicals," said Goldman Sachs analyst Glen Engel. "If you're ever going to trade the group, now is the time."

Engel's advice may seem to defy logic given that the industry lost roughly $7 billion last year and is expected to lose between $3 billion and $4 billion this year. The group isn't expected to return to profitability until much later in the year, possibly even sometime next year, and skeptics worry that the industry has been irreparably harmed by the terrorist attacks of Sept. 11.

AMR ( AMR) illustrated the problems facing the industry, saying Thursday it expects a "sizable" first-quarter loss and projecting a probable loss in 2002 as it continues to feel the impact of the terrorist attacks. Analysts expect the carrier to lose $4 a share this year, according to Thomson Financial/First Call.

Still, there have been nascent signs of a recovery in recent months. While industry traffic was down 13% year over year in January, it had been down almost 50% immediately after the Sept. 11 attacks and has been gradually clawing its way back as fears of flying have abated. Some carriers have already been adding back flights and using larger aircraft, although capacity is still down from year-ago levels.

"Traffic has come back much quicker than price," Engel said. "They still have to offer low fares to fill planes."

Fare and Square

According to the Air Transport Association, air fares within the U.S. fell 16% in January, and passengers paid about 14% less than last year to fly internationally.

"Their approach is to first get people back on board and consider increases after traffic has gotten back to more normal levels," said ATA chief economist David Swierenga.

When that will happen isn't clear, but Goldman's Engel isn't alone in the optimists' camp. Analysts say they are encouraged by signs of improvement in the economy, which bode well for the airline industry. Manufacturing activity stopped declining at a precipitous rate in January and new orders for transportation have been "quite strong," according to the Institute for Supply Management, formerly known as the National Association of Purchasing Management.

In addition, fuel costs have remained subdued and a number of carriers have taken significant measures to cut costs. The federal government's Air Transportation Safety and Stabilization Act has also offered some relief to the industry, providing $5 billion in direct cash grants and loan guarantees of $10 billion.

In a research note Wednesday, ABN Amro analyst Ray Neidl advised investors to overweight the group, saying the late spring and summer travel season should be strong and that stocks continue to trade at low levels.

The Amex Airline index (XAL) has surged 65% to 96 from a low of 58 on Sept. 21 but remains well below its levels before Sept. 11.

Neidl believes the carriers whose stocks have the potential to see large percentage increases include United Airlines, a unit of UAL ( UAL); America West ( AWA) and US Airways ( U), "mainly as a result of the low levels they are trading at."

However, he pointed out that the financially weaker airlines carry a lot of risk and that investors should focus on names like AMR, Delta ( DAL), Northwest ( NWAC), Southwest ( LUV), Continental ( CAL) and Alaska Air ( ALK). "We would remain aggressive buyers," he said.

Spinning

Recently, low-cost carrier JetBlue filed with U.S. regulators to go public. Last year, British Airways ( BAB) spun off Go in a transaction that made that carrier private. Similarly, one trend that has the potential to unlock shareholder value, some analysts say, centers around the plans a few airlines are developing to spin off their regional units.

Northwest has said it will hold an initial public offering for regional subsidiary Express Airlines I, which will be renamed Pinnacle Airlines. The number of shares and the price range haven't been determined yet, but the IPO is expected to bring in about $400 million.

Meanwhile, Continental has resumed plans for a $300 million IPO of its ExpressJet unit. The carrier expects to offer about 20 million shares at a price between $14 and $16 a share.

"We believe the announcement by Northwest and Continental to offer IPOs for their regional units may be a trend for major carriers as they attempt to unlock the value of the regional holdings and alleviate time allotted to managing (regional jet) operations," Neidl said.

The carriers need the cash infusions, and Continental might use at least part of the proceeds to pay down some of its heavy debt load, analysts said.

"While both companies will be losing very profitable subsidiaries, the cash that they will receive will go a long way toward seeing both airlines through the current downturn," said Morningstar analyst Jonathon Schrader. "In fact, these two carriers will probably emerge as two of the strongest in the industry."

As originally published, this story contained an error. Please see Corrections and Clarifications.

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