The Positive Beat Continues for the Airlines

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Only a month ago this article theorized that airlines might finally be investable. Fortunately both Delta Airlines (NYSE: DAL) and US Airways Group (NYSE: LCC) obliged the theory by reporting strong Q1 earnings. A quarter that is typically the weakest actually turned solidly profitable for two of the market leaders. In fact, Delta claimed the highest profit in over a decade.

Unless new competition comes out of left field or the unions get greedy by not being able to resist claiming a portion of all earnings gains, the sector could be poised for a golden decade.

Strong earnings from Delta

Delta reported a $124 million improvement in net income over last year by recording a net profit of $0.10 for Q1 2013. The company also generated $1.1 billion of operating cash flow and $457 million of free cash flow -- an incredible turnaround from an industry that not only struggles with yearly profits and typically has a dismal first quarter.

The numbers were solidly above the analyst estimates of a profit of $0.06. Passenger revenue only increased by $107 million or 1.4%, but the company along with the sector continues to see operational improvements as passenger unit revenue (PRASM) increased by a solid 4.1%.

Analysts forecast earnings of around $2.60 this year increasing to $3 next year. Based on Q1 results, the stock is extremely cheap as the company easily surpassed earnings in the most difficult period of the year. As an example, analysts expect earnings jumping to $0.95 for the next quarter. These numbers have a higher probability of reaching the high-end estimate of $1.07 unless the furlough issue trips up the friendly skies.

Strong earnings from US Airways

US Airways reported earnings of $55 million, or $0.31 per diluted share. This number easily surpassed analyst estimates of $0.28. The company is off to a solid start prior to the merger with AMR Corp. (NASDAQOTH: AAMRQ.PK) scheduled to conclude in the third quarter. As with the sector and normal of an airline at any period, it lost $0.13 in the first quarter last year.

The company reported record load factors that should only improve with the consolidation of American Airlines. While first quarter revenue increased at a 3.4% clip, the difference maker is that efficiency increased as available seat miles only increased by 1.3%. The increased efficiency allowed the small revenue increase turn the small loss last year into a $77 million improvement this year.

Analysts forecast the company earning roughly $3 this year making the stock extremely cheap based on the ability to beat earnings going forward.

Fuel costs the key

A major key to substantial gains in the sector would be large drop in the price of jet fuel. As an example, US Airways spent $1.13 billion on aircraft fuel in Q1. That amounts to 33% of the revenue spent on what most people consider a commodity. Even with all the advanced technologies that Boeing puts into the latest airplanes, the airlines currently spend substantially more money on fuel. US Airways only spent $320 million directly on airplane maintenance and rent and possibly another $100 million via the Express segment for a total of $420 million.

A dramatic decline in fuel costs would lead to short-term profit surges for the airlines.

Conclusion

At only 5-6x current year earnings estimates, the airline stocks are cheap especially if the sector has made a dramatic shift toward a focus on profits. The first-quarter reports from Delta Airlines and US Airways were very promising that the industry profit shift is legitimate. It remains to be seen whether the smaller regional plays will get more aggressive or if the unions will begin demanding more spoils from the profits fountain as in the past.

The sector has become a potential home run investment, but any investor needs to keep one eye on the news. Any day the alarms could go off as some billionaire gets the bright idea of starting up a major competitor. Load up on the stocks until that happens.


Mark Holder and Stone Fox Capital Advisors, LLC have no positions in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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