2 Stocks To Buy In A ‘Hated’ Sector

Imagine an industry that’s suffered cumulative losses of more than $50 billion from 1979 through September 2012.

Not to mention, the sector’s index has posted a -1.2% annual return during the past 20 years through 2012, compared with the S&P 500’s 8.2% return during the same time period.

My first thought upon learning about this dismal record was that this industry must be a dinosaur. Perhaps it was destroyed by the technology boom or something else not being used much anymore.

But nothing could be further from the truth.

This business attracts 2 million paying clients per day on 30,000 different high-cost excursions. In no way is it dying, but why the awful performance up until last year?

Believe it or not, deregulation hit this formerly high-flying business in 1978, resulting in price wars that eventually sent the individual companies into bankruptcy and a series of mergers.

Finally, due to consolidations, bankruptcy reorganizations and added fees for consumers, this industry is on the upswing.

If you haven’t guessed, I’m talking about the airline sector.

There has been tremendous consolidation in this sector during the past several years. Examples include Delta (NYSE: DAL) purchasing Northwest in 2008, and Southwest (NYSE: LUV) buying AirTran in 2011.

This consolidation has reduced the number of seats available helping to shift the supply/demand equation positively for the sector. In 2011, the average U.S. flight experienced an 83% occupancy rate compared with 69% 10 years earlier, according to trade group Airlines for America.

In addition, bankruptcy seems to have taught the industry a lesson or two. Rather than continuing to engage in no-win price wars with one another, carriers have resorted to cost-cutting measures, such as slashing flights to unprofitable locations to focus on profitable routes. A variety of new fees, such as for luggage, seat size and snacks, has also been instituted to boost revenues.

Let’s take a close look at my two favorite airline stocks that stand to profit from these new trends.

Southwest AirlinesBoeing 737
This originator of discount air travel is a specialist in keeping costs low and has been in a solid uptrend since mid-December 2012. Its cost-cutting measures have enabled it to earn a consistent operating profit in each of the past 39 years.

Southwest uses one type of aircraft, the Boeing (NYSE: BA) 737, and flies to point-to-point destinations rather than using a hub system like its competitors.

After the recent purchase of AirTran’s Boeing 717 fleet, Southwest made the wise decision to lease those planes to Delta instead of incorporating them into its fleet and departing from its single-aircraft philosophy.

The airline has a price-to-earnings (P/E) ratio of just under 23 and a market cap of more than $9 billion. The stock had surged more than 20% this year before hitting resistance in the $13.50 area. Shares have fallen back from the highs but remain in the value “buy” zone, setting up an ideal technical buy opportunity.

Delta Airlines
Widely regarded as the industry leader, Delta agreed to acquire 49% of Virgin Atlantic in December 2012.

In addition, the company announced it would purchase an oil refinery in an attempt to control fuel costs. Delta expects about $300 million a year in savings from the move.

The airline specializes in business-class seating, which generally creates higher revenues than coach passengers. Delta is looking to provide some business-class passengers with amenities such as flat-bed seats, HBO TV programming, fresh-cooked meals and other luxuries.

The company boasts a market cap of just under $13 billion and a P/E ratio of just below 13. Shares have soared nearly 23% this year before hitting resistance at $17. The stock has since fallen back into the value “buy” zone, setting up an ideal buying opportunity.

Risks to Consider: Rising fuel costs are the biggest risk to airline stocks. In addition, this business’s fortunes are highly correlated with the health of the economy. Always use stops and position size properly when trading.

Action To Take –>
I think Delta and Southwest are great buys right now from a technical and fundamental perspective. There is little reason to expect fuel prices to increase, and the economy has plenty of upside. My 18-month target prices are $22 for Delta and $20 for Southwest.