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Tickers in this Article: SKYW, RYAAY, ALK, DAL, UAUA, LUV, AMR, LCC
Part of the recent rally in some, though not all, airline stocks clearly was fueled by the tumble in oil prices. However, have you noticed that a few of these air carrier names (the smaller ones much more than the major ones) have grown their own wings and continued to rally even when crude prices were trying to recover? Maybe it's time to go shopping - selectively.

Oil And Airlines
It's no coincidence that oil's peak of $144 per barrel on July 11, 2008 was just two trading days before the Dow Jones Airline Index (DJUSAR) made an intermediate-term bottom. That rebound/rally lasted all the way through September 16, translating into a 72% gain.

Here's the really interesting part: Oil continued to sink (and still is), yet the DJUSAR – packed with large cap American carriers – is down 20.1% since that peak.

Major Airlines Were Unprofitable In 2008
Perhaps that's the way it should be, though. Delta Air Lines (NYSE:DAL), UAL (Nasdaq:UAUA), AMR (NYSE:AMR) and the other majors were all unprofitable in the fourth quarter of 2008 as well as the whole year. I don't see how 2009 could be significantly better.

Even more interesting is the fact that the S&P Mid-Cap Airline Index is up 136.6% since July 11, while the S&P Small-Cap Index is up 45.9%.

My point? The big airlines are apparently still doing something wrong, though the smaller (and foreign) airlines are doing something right. At least that's what their stocks are saying. I'm taking the hint at face value. More importantly, I'm willing to tap into the small and mid-cap airline uptrend with a few selective picks.

It's actually a bitter irony when you think about it. Airlines had been paying – okay, passing along to customers – those higher fuel bills. But cheap oil means cheap fuel, which in turn means passengers can afford to fly again. Problem solved, right? Not quite.

The Recession Factor
Though the recession chewed away about two-thirds of the price of oil, it's still a recession – not exactly an economic environment that spurs a lot of air travel (particularly when we're still paying a per-bag surcharge). Fuel may be cheaper now, but fewer people are flying, so that really doesn't matter. (Find out how this economic cycle affects both small and big business; read The Impact Of Recession On Businesses.)

So, how do I explain the disparity between the large-cap and small-cap airline stocks? Simple - the smaller carriers are more apt to be nimble on the financial side of business. They've figured out how to balance elastic demand and fluctuating fuel prices. Many foreign airlines have effectively done the same.

Best Of The Small Airlines
From the relatively small groups of companies that can walk that thin line, there's a handful I feel actually make for decent potential investments right now. In no particular order, I think Alaska Air (NYSE:ALK), Ryanair Holdings (Nasdaq:RYAAY) and SkyWest (Nasdaq:SKYW) are far more deserving of a look than the likes of Southwest (NYSE:LUV) or US Airways (NYSE:LCC). (Break through the clouds to see if these stocks will rocket higher or crash and burn; check out Is That Airline Ready For Lift-Off?)

How To Pick Winners, And Where's That List From?
Primarily, they're recent survivors - carriers that have sustained reasonable operating profitability in a tough environment over the last six months. I like their forecasts, too, even if shockingly optimistic.

Take Alaska Air, for instance. This smaller airline booked an accounting loss for the quarter ending September 30, but only because of charges related to hedging against high fuel costs. Had it not been for the hedge, a necessary level at the time, the company would have had earnings per share of $1.10. The need for such hedging is considerably diminished now that oil is trading lower, and I suspect we'll see the carrier make a measurable migration into the profitability analysts expect in 2009. (Examine various ways in which companies use derivatives to manage risk; check out Corporate Use Of Derivatives For Hedging.)

SkyWest was profitable each of the four quarters through September 30, verifying that it's not an impossible task to deal with expensive oil. Secondarily, I appreciate the way smaller airline stocks have been behaving (i.e. rising). Alaska Air shares are up 191% from July's low; SkyWest shares have gained 55% over the same time frame.

I know that's not very "fundamental" of me, but hey – a great company's falling stock is still a falling stock. There's no need to avoid keeping the wind at your back.

Coming In For A Landing
In any case, I think some smaller airlines are worth a closer look now, and they could stay that way as long as oil stays relatively stable (and under $75). I'd still keep these stocks on a short leash, though, and remember - it's not an industry-wide optimism.

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