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US airlines attract investors with better returns
March 16, 2013
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ATLANTA: US airline stocks, long derided as investment duds, have been gaining altitude in recent years. Now, some see room for them to fly even higher.

Recent mergers have brought in new, profit-focused managements who are running larger, leaner operations than in the past. Unlike their flashy predecessors who focused on expansion and engaged in costly fare wars to win customers, today’s chief executives are number crunchers and lawyers who aim to make their airlines efficient and profitable.

“The days of the larger-than-life, market-share driven management are over in this business - and that’s a good thing,” United Continental Holdings CEO Jeff Smisek said at an investor conference this month.

Airline CEOs “are very focused on being professional managers” and on “providing appropriate returns for our shareholders.”

Delta Air Lines acquired Northwest Airlines in 2008, United merged with Continental in 2010 and Southwest Airlines bought discount rival AirTran in 2011.

 With fewer big carriers competing, ticket prices have risen. The average fare rose about 8 per cent to $375 in the third quarter of 2012, compared with $346 in 2008, according to the US Bureau of Transportation Statistics.

If the recently proposed American Airlines-US Airways Group merger is completed, the four biggest US airlines will control more than 80 per cent of US industry capacity.

“That should translate into what we’ve already seen since 2009, which is better pricing power,” said Robert Mann, an airline consultant in Port Washington, New York.

 With the exception of JetBlue, big airline stocks have outperformed the S&P 500 by a wide margin since the stock market hit its post-crisis bottom in March 2009.

Some signs suggest they’ll keep outperforming their bonds and the broader market. The median price of airline stocks is 8 times forward earnings, compared with 14 for the S&P 500.

 Airline debt has also been a winner, with a widely watched index of their bonds at a record high. From the high-yield corporate bond market’s low point in December 2008, air transportation bonds have delivered a total return of 143 per cent compared with 124 per cent for junk bonds overall, according to Bank of America Merrill Lynch Fixed Income Index data.

Of course, airline investors have been burned many times before. Billionaire investor Warren Buffett joked about airline investing after a rough ride when he bought US Airways preferred shares in 1989.

“The worst sort of business is one that grows rapidly, requires significant capital to engender the growth and then earns little or no money. Think airlines,” he said in 2008.

The industry had its worst decade ever after the Sept.11 attacks on the World Trade Center and the Pentagon in 2001, racking up billions of dollars in losses and destroying share value in airlines that went bankrupt. A $100,000 investment in American parent AMR Corporation made at the end of 1999 would have been worth just over $72,000 two years later.

And while profits are starting to flow now, many investors remember that previous advances have been snuffed out by spiking oil prices, labor unrest, recessions or terror attacks.

“The investment case is still a work in progress,” said Eric Marshall, co-manager of the Hodges Small Cap Fund, which owns shares of US Airways Group. “Airlines are very under-owned among institutional investors and retail investors.”

Still, many carriers just marked their third straight year of profitability, despite high oil prices. Carriers have pared unprofitable routes, scaled back flying to match demand and adopted technologies that have helped them sell more services and cut expenses.

 Airlines “have survived in this $100-a-barrel-oil environment just by being very careful managing their costs,” said Marshall. Even with their recent rally, Marshall expects the investment case will improve over the next five to 10 years.

Carriers also are getting creative in their efforts to lift financial performance. Delta bought a refinery last year to gain control over fuel costs. The facility is expected to generate a profit of $75 million to $100 million in the second quarter.

 Southwest, which long held out against extra charges, this year rolled out a $40 fee for consumers who want to be among the first to board under a plan to improve revenue and earnings. And airlines are paying greater attention to metrics such as return on invested capital (ROIC), a measure of how efficiently a company is using its money.


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