The Case for Airline Stocks: Lower Fuel Costs, Fewer Seats, and Some Short Memories

Now that airline passengers are picking up the tab for everything from luggage to jet fuel, major carriers like Delta Air Lines (DAL), United Continental (UAL), and US Airways Group (LCC) are making decent money. And for the moment anyway, so are their shareholders.

DAL Chart

DAL data by YCharts

Think it will last this time? Long-term investors have had mixed success in this sector, where costs are huge and bankruptcies are a favored form of debt reduction. Here’s a look at return on invested capital for these airlines (all after cleaning out previous investors with bankruptcies) compared to a few companies of similar sizes in other industries. Note not only the difference in returns, but the relative stability of returns from those other-than-airline companies.

DAL Return on Invested Capital Chart

DAL Return on Invested Capital data by YCharts

Nevertheless, investment advisors have flooded these three airlines with buy recommendations lately, and it’s easy to see reasons for the optimism.

The biggest boon for airlines this year has been the drop in the price of jet fuel, the single largest operating expense for any carrier. It’s down significantly in the past few months, and the forecasts are good for the low prices to continue.

US Gulf Coast Jet Fuel Spot Price Chart

US Gulf Coast Jet Fuel Spot Price data by YCharts

The companies passed on the higher fuel costs to customers and aren’t likely to give back those price gains on a drop. Also, passengers have come to accept that the ticket price is just the beginning of what they’ll shell out to an airline before their travel is done. Fees do wonders for underlying earnings, including those for “services” like checking baggage, booking by telephone, using frequent flier miles or sitting next to wife and son instead of spread out in three middle seats.

DAL EBITDA TTM Chart

DAL EBITDA TTM data by YCharts

Still, there are a couple of reasons for conservative investors to worry about investing here. Chasing fuel cost trends has backfired for investors before because airlines’ attempts to stabilize these costs don’t always work. Company hedges on fuel prices sometimes save money; sometimes cost money. Delta took a novel approach to the problem recently by buying a refinery. It will help Delta’s bottom line if the airline can run that business more profitably than did its previous owner, ConocoPhillips (COP), a company that’s been running refineries for about a century.

But the bigger worry is the reason behind those fuel price forecasts: weak economies. The price of jet fuel is a derivative of the price of oil, which goes up and down on the strength the world’s economies. When economies are depressed, the price of oil goes down because demand for oil goes down. So, ironically, does demand for airplane tickets. Any more bearishness on the general economic outlook will almost certainly cause analysts to rethink their improving profit forecasts for airlines.

And yes, underlying earnings are in the black again, which is a nice change from 2009 or other previous years. But little of that trickles down to the shareholder level because all of these businesses, by nature of the enormous cost of buying, housing and maintaining jets, have a ton of debt to maintain. Delta also has a heap of underfunded pension liabilities. US Airways may be headed toward a merger with recently bankrupt American Airlines. YCharts Pro rates each of these major airlines as weak on fundamentals.

That merger news has helped to more than double US Airways’ share price this year alone, and that’s enough to make one forget the 40%-plus drop of the previous six months. Obviously, it’s quite possible to make money investing in airlines. But if you plan to be in this sector for the long haul, you might want to keep that sick sack handy for the ride.

DAL Chart

DAL data by YCharts

Dee Gill is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.

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