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NEW YORK – Heading into the holiday season, even the occasional flier is taking to the skies. Though the airline industry continues to be fraught with problems, are there potential investment opportunities you may want to look into?
The airline industry has historically been a poor long-term investment, says Will Randow. He recently began covering airlines for Citi Investment Research, and suggests investors view them as short-term trades. Southwest Airlines is his top pick, which he rates “buy,” along with JetBlue. He rates American Airlines’ parent AMR Corp., and Air Canada as “hold.”
Q. Was there ever a golden age for airline stocks?
A. You have a few blips. If you look back into the ’90s, as well as the 2004 time frame, there were a few years of solid performance. But a lot of times, it’s met with a long history of underperforming relevant benchmarks.
Q. Why is that?
A. Our general view is the industry’s poor return on capital is the main driver. If we want to take that a step further, it’s the industry’s lack of pricing power.
Q. Because there is too much supply of airplane seats available?
A. Everybody’s looking to sell a seat. You have new entrants: the low-cost producers, such as Southwest and JetBlue. You also have the legacy carriers who don’t want to exit the market. The initial guidance we got from a number of these legacy carriers is they are not going to cut any additional capacity (overall supply of seats) in 2010. They are looking to grow to make up for capacity cuts wrought by fears of H1N1. It looks like that problem is not going away.
When you think of it in an even bigger picture – what’s led to this overcapacity is continuous access to new capital, even for the most distressed carriers. That’s either through the capital markets or aircraft manufacturers or business partners. It’s a tough industry to operate in.
Q. Do you think the threat of bankruptcy is over, at least for now?
A. That’s a tough question to answer. We are seeing revenue comparisons get less bad. In the third quarter, people are looking for revenue per mile flown to be down 5 percent to 10 percent, compared with 20 percent in the prior quarter. When we enter 2010, our forecast is industry revenue will be up 5 percent.
But you have some key issues: There still is some uncertainty with regards to the economy, there is still high unemployment and the other big one is oil.
Q. What’s more important for airline stocks: the economy or fuel prices?
A. I think the economy is definitely No. 1. I think oil is a big pressure point, but if you have a strong enough economy, you can offset it with fare increases.
With that being said, a number of these carriers have raised significant amounts of capital through investors. Given our assumption of $85 per barrel oil, we think the balance sheets are in OK shape, of the ones we cover.
Q. For many airlines, first-class passengers are subsidizing those in the cheapest coach seats. Can that business model continue?
A. The industry view is generally that business travel will improve next year and possibly 2011. I would tend to agree, but I think it would be more 2011, just because the unemployment rate is going to stay near 9 percent. How does business travel improve if unemployment doesn’t? I think it might take more time.
Everything that’s been expressed by management teams means they’re not looking to cut the front cabin anymore. I think the business model is not going to change. That being said, I kind of like the idea of JetBlue’s business model, where you have an almost premium coach offering throughout the plane.
