Airline Stocks Look Set To Soar

By Seth Kaplan | March 09, 2010 AAA
Airline Stocks Look Set To Soar

The International Air Transport Association (IATA) says airlines will lose $5.6 billion this year. That sounds like a sector investors should avoid, right?

Maybe not.

Of 36 major commercial airlines worldwide that have reported earnings for the fourth quarter of 2009 so far, 24 of them, or 67%, reported operating profits (excluding special items). These include carriers with varying business models and from every region of the world. Not bad given that the fourth quarter traditionally is an off-peak period for airlines. (Find out

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what metrics you need to examine when researching stocks in this sector in Is That Airline Ready For Liftoff?)

Why the disparity between the good news and the dark headlines? IATA's figures include only member airlines - not high-flying, low-cost carriers like Southwest Airlines (NYSE:LUV), Ryanair (Nasdaq:RYAAY) and AirAsia. All three were solidly profitable in 2009.

It's also important to note that industry figures can be skewed by a few airlines. IATA estimates that its 200-plus members collectively lost $11 billion last year, but just three airlines - American Airlines (NYSE:AMR), Air France/KLM and Japan Airlines (shares suspended due to bankruptcy) - accounted for half the red ink.

Behind those figures a lot is going right for the industry. Fuel prices have been remarkably stable for the past six months, enabling carriers to focus on adjusting capacity and cutting non-fuel costs.

Carriers today can live with $80 per barrel oil, thanks to their ability to shrink their way to profitability. The world will likely have too many hotel rooms for years to come, but airlines have already retired enough old aircraft, slowed delivery of new planes and even increased fares. What's more, the tight credit environment has reduced the risk that cutting capacity will lure start-ups into the market.

Airlines are also benefiting from improving productivity. They are doing so by eliminating middlemen from the sales chain, getting passengers to serve themselves at check-in kiosks, exacting more flexible terms from labor groups and operating more efficient new planes.

How can you profit from the updraft? One way is to invest in airlines is via the Claymore/NYSE Arca Airline ETF. This fund is up 9% in 2010 and 122% over the last 12 months, easily beating most major indexes.

A more targeted approach would be to buy shares in individual carriers. Here are a few things to consider as you evaluate airlines:

The business model: The airline world is broadly divided into legacy, meaning full-service carriers like Delta Air Lines (NYSE:DAL) and low-cost carriers like Southwest. The labels are imperfect, but over time big discounters have tended to be more successful at sustaining profitability than have large legacy carriers. Many low-cost airlines profited during the boom and during the downturn, whereas few legacy carriers profited at the depths of the downturn.

A low-cost region: In the Middle East, Southeast Asia and Latin America even legacy carriers have often produced profits in bad times. Dubai-based Emirates (which is privately held) has luxurious sleeper suites on jumbo A380s and certainly isn't a budget carrier. But in a region with low labor costs, it is indeed a low cost carrier compared to its European rivals.
Other examples of not-so-obvious low-cost carriers whose shares do trade publicly include:

Turkish Airlines (THYAO-TI): Like Emirates, it competes against European giants with a premium product and low labor costs. Its Istanbul hub is well placed to handle many popular global itineraries. Turkish Air continues to grow profitably, and its stock is up nearly 500% in the past 12 months.

LAN (NYSE:LFL), based in Chile, and Copa (NYSE:CPA), based in Panama, have far lower labor costs than airlines like American, with whom they compete directly on many routes.

Most global airline investors are familiar with Singapore Airlines (OTCBB:SINGY) and its long record of profitability. Far fewer know that nearby Thai Airways has lost money in only one year in the past 45. Malaysia-based LCC AirAsia makes the most headlines but its rival Tiger Airways earned a 17% operating margin in its first quarter since going public.

The airline business will invariably remain a bumpy one, with inevitable threats from oil price spikes and global epidemics. At the moment, however, the risk of turbulence ahead seems to be masking some very bright prospects.

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