These Surprising Stocks are Ignoring the Market’s Gravity
As far as many investors are concerned, airline stocks should be avoided like the plague. Every time the economy hits a rough patch, these heavily-indebted companies look as if they’re lunging toward bankruptcy. Countless investors have had to dump airline stocks after losing most of their investment, vowing “never again.”
Truth is, this whole industry makes for lousy investing but great trading. At the bottom of the economic crisis, for example shares of United Airlines parent UAL (Nasdaq: UAUA) fell to $3 as the company faced open-ended losses. Shares are up +800% since then. If history is any guide, share prices will fall sharply again once investors are spooked by a slowing economy or a spike in oil prices. And after that, shares will again post a sharp rebound. You just have to play the cycle. Buy-and-hold doesn’t work here. The swings may not be as wild as in the past, though, as carriers have learned to live with less debt and lower costs — ingredients crucial to surviving a downturn.
Right now, the airline industry is benefiting from many tailwinds, and the AMEX Airline Index (AMEX: XAL) has risen +15% since early May, even as the rest of the market was slumping. During the past five trading sessions, the index has risen +10%, the best gain of any sector. Gains are coming from a combination of good passenger statistics from the airlines, and positive analyst comments.#-ad_banner-# Importantly, this is an industry on which you need to do your own research. The analysts that follow the airline stocks have a tendency to only slowly update their outlooks and forecasts, even as salient data come in much more frequently. For example, the price of oil may fall from $80 to $70 a barrel, but many analysts won’t let that important factor alter their forecasts until the next time quarterly results are delivered. Not to bash the analysts — they are a bright group with deep industry knowledge — but their stock-picking record has not been stellar.
So how can you do your own research? By keeping tabs on the following major factors. If you do, you’ll have a sense of when to buy or sell these stocks before the analysts change their ratings:
Oil prices. Jet fuel is a bit more expensive than gasoline, but its pricing largely correlates with the direction of oil prices. Sharp moves up or down in the price of oil are a big factor. Airlines start to feel real pain as oil prices rise, but they don’t always benefit when prices fall. That’s because falling oil prices are often related to concerns that global economic activity may be cooling. Generally speaking, oil prices between $60 and $80 a barrel represent an ideal range for airlines as these levels signal a healthy economy yet manageable fuel costs. As a personal rule of thumb, I would never buy airline stocks when oil prices are outside of that range.
Hedging. But that logic does not apply to the carriers that are wise enough to lock in jet fuel prices when they are lower. If you have the time, peruse the recent SEC filings where carriers discuss how much of their future fuel needs are hedged, for how long and at what price. Rising or falling prices affect different air carriers to varying degrees. Earlier this spring, an analyst upgraded U.S. Airways (NYSE: LCC) when fuel prices dropped. U.S. Airways had neglected to hedge, so it stood the most to gain from oil’s fall.
Domestic vs. international. A clear dichotomy has emerged in the global travel market. The U.S. market is quickly improving, as more seats are filled at higher prices. Year-over-year profit comparisons for domestic-focused carriers such as Southwest (NYSE: LUV), JetBlue (NYSE: JBLU) and U.S. Airways are going to look very good in the June quarter. If the U.S. economy keeps rebounding and unemployment drops over the next year or two, then profits should spike well higher from here for these names. Notably, their bigger rivals have cut back on many routes, so competition is less intense. The major carriers such as AMR (NYSE: AMR), the parent of American Airlines, and Delta (NYSE: DAL) could be hurt by further economic troubles in Europe, though their U.S. business should look quite good.
Merger mania. Delta‘s decision to merge with Northwest has proved to be a smart move, as excess costs and overlapping routes were pared. Now, investors expect to see the same synergies result from UAL’s merger with Continental (NYSE: CAL). The deal is not only good for those two carriers, but for the whole industry, as it leads to more rational pricing schemes. It also can be a boost to the low-cost carriers like Southwest and JetBlue that look to build market share in areas where the big carriers have pulled back too much.
Action to Take –> Despite the recent move, airline stocks still look very attractive — if you believe that the economy will keep improving. But know that these shares could sharply retrench if oil prices rise or the economy loses steam. I remain a fan of Southwest and JetBlue, as they have proven they can avoid losses in the bad times and still post solid profits in the good times.