|
After being battered with terrorism, rising fuel prices, and pension obligations, the U.S. airline industry and their share prices have been in serious financial trouble over the last few years. But now the clouds have seemingly parted and airline stocks are reinvigorated and on the rise.
During the worst ever slump in the history of the airline industry (2001-2005), four of the six major carriers declared bankruptcy. Those that didn't declare bankruptcy operated with heavy losses. For example, American Airlines lost over $3.5 billion in 2002, and subsequently, its stock fell below $2 per share. Reeling from the drop off in passenger traffic after September 11th and the ensuing recession, as well as being thoroughly undercut and outmatched by the newer "discount airlines," the future prospects for the major airlines were hopelessly bleak.
Now, after several years of cost cuts and restructuring, a recent fall in fuel prices and strong travel demand has put airlines back in the black. The industry posted a profit of $2.3 billion for 2006 (the first in six years). American earned $231 million in profit for the year, while Continental Airlines announced $343 million in earnings. And United Airlines reported a $25 million profit -- and astounding feat since the company emerged from bankruptcy just 11 months ago. Moreover, the Air Transport Association of America is projecting a $4 billion profit for passenger and cargo airlines in 2007. A profit in both 2006 and 2007 would constitute the first consecutive yearly profit in the industry since 1999-2000.
The U.S. airline industry consists of two tiers. Tier one is the so-called "legacy carriers" or "majors" (American, Continental, US Airways, Delta, United, Northwest). They are the behemoths of the industry with enormous fleets and routes all over the globe. Tier two is the "discount airlines," most notably Southwest, JetBlue, AirTran, and Frontier. Their focus is usually only on domestic routes, and they use their lower cost structure to undercut and steal market share from the major airlines.
` Legacy carriers have been saddled with pricey labor contracts and huge pension obligations acquired in an era before deregulation and price competition. They also contend with fierce competition internationally from foreign carriers. The new upstart airlines, however, are unburdened by the problems of the legacy airlines. They are able to focus entirely on servicing the domestic market at a lower cost to the consumer. For several years, it seemed as though the old majors were becoming relics of a bygone era, and the future belonged to the discount carriers.
Recently, there has been a reversal of fortune. The older, larger have undergone years of massive restructuring and cost cuts. Most of the legacy carriers, through the process of bankruptcy, have renegotiated labor contracts and reduced obligations to retired employees, thus mitigating their disadvantages. The benefit of these actions has become tangible, as falling oil prices have combined to move the majors to profitability. In addition, they’ve been able to use revenue from the more profitable international routes to lower costs domestically and take on the discounters. This shift between the tiers is exemplified by the stock prices of two key players. American Airlines has rebounded from a low of under $2 in 2003 to nearly $40 today. JetBlue reached a peak of over $31 in 2003 and now trades below $15.
While it remains to be seen if the discounters will be able to compete with the newly revamped and reinvigorated majors, the legacy carriers are not without their own problems. Labor unions, which have already yielded massive concessions, could strike and cripple an airline for some time. Furthermore, a huge amount of effort is required to keep earnings stable while simultaneously maintaining or growing market share.
The entire industry is also subject to the ceaseless uncertainty of oil prices. Oil prices are a huge factor determining the profitability of any airline. Crude oil prices averaged $66.05 per barrel in 2006. But prices came down to nearly $50 per barrel in the second half of the year. This price drop rapidly catapulted the entire industry into the black. The Department of Energy has forecasted an average price of $64.42 per barrel in 2007. According to the research firm AirlineForecasts, $55 per barrel oil could jettison airline profits to $6.9 billion in 2007. Conversely, higher-than-expected oil prices could have the reciprocal effect on profits.
Although many analysts are bullish on the airlines for the next year, airline stocks are not for the faint of heart. The industry is fraught with risk and has confounded investors since its early days. In addition to oil price and labor risks, the industry is extraordinarily cyclical. A downturn in the economy could cause a drop in passenger traffic that evaporates profits. Meanwhile, competition from both domestic and foreign carriers is fierce, which serves to trims margins. And of course, there is the omnipresent risk of another terrorist attack.
All this has spawned merger and acquisition fever in the industry. United Airlines and Continental Airlines are talking about a merger that would create the largest domestic airline. US Airways made a play for Delta Airlines, but recently withdrew its offer. AirTran offered to buy Midwest Air Group. Though much of the deal making is preliminary, the floodgates are opening. There are other deals in the works and more will surely follow. The airlines seek consolidation primarily to reduce competing flights and price competition. With fewer flights available, the airlines believe they can raise prices and increase profit margins.
Airline stocks have come back to life. They’ve made surprising progress, and there
is a positive outlook for the coming year. However, the industry is still terminally uncertain.
-- Tom Hutchinson
|
|
Income Security
of the Month
If you're looking for
high yields, monthly payments and unprecedented safety from your
investments, then you need to learn more about our "Income
Security of the Month" for November 2008. This stable
preferred stock has a long
track record of paying some of the most solid dividends in Wall
Street history. In fact, the preferred issue pays a monthly dividend
totaling 10.3% annually
and has
outperformed the S&P 500 by more than +44 percentage points over the last
year!
|
Top
10 Stocks for 2008!
Since we began publishing this report back in 2003, the picks we've
featured have consistently beaten the broader market -- delivering average
gains of +21.3% per year and outperforming the S&P by a nearly
2-to-1 margin. Act now to reserve your copy of our newest report -- Top
Ten Stocks for 2008. |
|
|
