A Bullish Case for Airline Stocks

By Michael Nolan - September 27, 2012 | Tickers: DAL, SZYM, BA, UAL, LCC | 0 Comments

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I've always been weary of the airline game. I know I'm not alone, either: many investors that I've spoken too also prefer to keep their distance. But, I recently sparked a discussion with a fellow investor who is a long-term airline investor, and while I am not planning on throwing my wallet into the airline stocks just yet, or even maybe ever, I have opened my eyes to a bullish perspective on airline stocks that I would like to share with you bears.

The airline industry scares me because it presents so many risk factors: the capital costs (airplanes, mainly) are high, fuel costs frequently spike and fall (or at least too often for me), labor disputes that have seemingly become more common, and skyrocketing debt levels have often sent me running. Frankly, I just don't believe that I would have success in such a risky field, even though I know others do, and I highly respect that. Here is what some bulls consider.

Fuel solutions

In my opinion, the fluctuation in fuel costs was one of the reasons I stayed away from the airlines. However, times are changing in the airline fuel industry. Plane production giant Boeing (NYSE: BA) is well into the production stages of their new 787 aircraft, which has a revolutionized wing shape to increase fuel efficiency up to 20%. According to a recent press release, Boeing has even "incorporated airplane health-monitoring systems that allow the airplane to self-monitor and report systems maintenance requirements to ground-based computer systems" that could prevent fuel leaks and maximum fuel efficiency. Furthermore, "advances in engine technology" like the new Rolls-Royce engines "are [also big] contributors to overall fuel efficiency improvement." Airlines are already impressed--so much so that Boeing is backlogged with orders and have already initiated plans to make more, according to their website.

As expensive as it may be, airlines are trying to get out with the old and in with the new, scrapping old "clunkers" and laying out the cash for newer, more fuel efficient planes. American Airlines (PINK: AAMRQ) has even ordered 460 newer and more efficient planes in order to lower their fuel costs. It may be past time for American to act in one way or another: American is knee deep in bankruptcy pressure and have recently been forced to cancel hundred of flights for the upcoming month due to bankruptcy proceedings and layoffs.

Another solution to the fuel issue is alternative fuels. Solazyme (NASDAQ: SZYM), an alternative fuel producer, leads the way in the industry. They currently produce an algae-base biofuel that was recently put to the test when United Airlines (NYSE: UAL) flew a plane powered by the new fuel in an interesting demonstration designed to raise awareness in the concept and show off its practicality. However, the costs of this fuel simply can't compete.  Solazyme does have hopes to drop the price to, at the highest, $80 per barrel over the next several years. Their PR "stunt" is actually getting some recognition too, especially now that United has run a TV ad detailing their involvement with Solazyme and alternative fuel business. However, a 13.7% drop over the past month and horrible equity and cash flow figures have me recommending "sell" for now. I'll reconsider when Solazyme has come closer to their goals. 

Mergers and acquisitions

The airline game has completely changed in recent years with merger after merger of major airlines. Aside from many smaller (relatively) mergers involving companies like US Airways (NYSE: LCC) (a very active company of the past few weeks--they have made many moves, including partnering with Skywest Airlines, announcing a $53 million airplane financing deal, and more) and Delta (NYSE: DAL)  (another busy bee--they have struck a deal with fuel companies in addition to decreasing the amount of flights they operate by 5%,) the recent United-Continental merger greatly changed the industry. The size of this merger has changed the game, especially for those who were frequent Continental fliers. These consolidations (and mainly the United-Continental merger) reduce the competition (by literally buying them) and cut overcapacity. As an airline passenger, this certain raise in ticket price doesn't thrill me, but if I were a stockholder, it would bring a smile to my face. Increased revenues due to ticket prices could be just what the industry needs, too. Check out (in 1995 dollars) how the average ticket price has fallen in recent years.

SOURCE: Bureau of Transportation Statistics

The Foolish Bottom Line

While increased revenues are critical, they are not enough to keep these airlines successful. Cost cuts are crucial, but alternative fuels and more fuel efficient planes may be just the solution. Granted, I am still a bear in the airline industry and have no positions in any of the stocks mentioned, investors not scared of risky investments (or what to me seems risky) should consider the potential upsides in the coming years.

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