Buy This Airline Stock After Delta Leads Sector Sell-Off

Sammy is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

On Tuesday, as shown by the chart below, shares of the major airlines, US Airways (NYSE: LCC), United Continental, Delta (NYSE: DAL), and Southwest all traded sharply lower despite a more than eighty-point gain during the trading session by the Dow Jones Industrial Average. 

DAL data by YCharts

Delta Leads The Way

The industry wide sell-off was led by Delta after the company reported disappointing results and cut its outlook. Delta said it expects a rise of 4 to 4.5 percent in first quarter revenue as compared to the same period a year ago. Previously, Delta had forecast a 4.5 to 5 percent rise in revenue. The negative reaction in the stock is, in my opinion, due mostly to the fact that Delta shares have been moving sharply higher of late. Over the past six months, as shown by the chart below, even after the recent decline, Delta shares are still up close to 50%. Judging by the sector wide decline during the trading session, traders and investors seem to be betting that the Delta results are not a company specific event, but rather a sign of industry wide problems. 

DAL data by YCharts

Buy US Airways

Traders and investors alike should take advantage of the Delta led decline and buy US Airways, my favorite airline stock. The move higher in airline shares to multi-year highs has not been solely based on an improvement in operating results, but rather an improvement in the outlook for the industry. The combined impact the Delta- Northwest , United-Continental, and most recently US Airways- AMR mergers have changed the industry. Investors have been betting that with significantly fewer players, the airline companies will have better pricing power and, in the end, be able to earn sustainable profits. Even Jim Cramer is buying into the idea that the airlines might actually be a good place to invest. This is notable because Cramer had long vowed never to recommend an airline stock. In addition to benefiting from the changing dynamics within the industry, US Airways has the added advantage of benefiting directly from the recently approved merger. The combined value of US Airways and AMR has been said to be worth close to $11 billion. Current US Airways shareholders will own 28% of the company, meaning that US Airways should be worth just more than $3 billion. Currently, US Airways is worth just $2.6 billion. Over time, I expect the value of US Airways to move up approaching the $3 billion mark. 

Valuation

As shown by the chart below, despite the optimism surrounding the industry, airlines continue to trade at depressed valuations. Because of this, I believe airline stocks will continue to move higher even with less than great results. In particular, US Airways seems the most undervalued based on PE ratios.

LCC Forward PE Ratio data by YCharts

Conclusion 

Investors and traders alike should use Tuesday's decline as an opportunity to buy airline shares. The major trends behind the rally have not changed. Yes, Delta's results were disappointing, but the stock trades at just 5.6 times forward earnings. More important than operating results is the theme that airline profits might, for the first time in recent history, be sustainable. If airlines are able to prove that the long-term fortunes for the industry have indeed changed then shares are a bargain at current levels despite weaker than expected results. My favorite way to play the sector is US Airways as I expect the stock to perform well as its merger with AMR closes.   


Sammy Pollack has no position in any stocks mentioned. The Motley Fool recommends Southwest Airlines. 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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