Airline Stocks With the Potential to Let You Fly in Style

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

Airlines are tough investments. I always see amazing profits or horrible losses. Rising fuel costs turn casual travelers off flying. The solution to flagging profits is to pack seats tighter and tighter. That makes people want to travel even less.

The key things for airlines is having the newest fleet, controlling costs, closing unnecessary routes, and customer loyalty. You would think that consumers would be fickle, but most people will go back to airlines if they have a pleasant experience. The reason is that flights can be so long that it is not worth it to them to be miserable, especially if they have things that need to be done when they land. Who wants to start a vacation being completely irritated because your knees are filled with fluid sitting down. That might be extreme, and there are people that need to travel on a budget. However, if your favorite airline is only $50 more you might go with them. I would choose Virgin America even if it were just a bit more expensive, because I have always had a pleasant experience.

The whipsawing of airline earnings mean that it is tricky to apply a buy and hold strategy. Keeping an eye on these companies is critical. However, the economy is still in a slump. If it starts improving, specifically if unemployment goes down via job creation then people might travel more for leisure. If they do that then it would be good for the airlines. Since airlines are pretty high-risk I would like to focus on cash flow, but will also look for net income and revenue growth. Having cash to pay the bills is always a good thing. Free cash flow is what I will look at, but other factors are important to judge the future of the companies.

The Best in a Terrible Class

If you have ever done research into airlines you can understand my cynicism. That being said they are companies that sometimes post monumental profits. For example, when they bump up prices to cover increased fuel costs, then oil collapses and prices stay just as high. On top of that, you are still charged a fuel surcharge. When fuel prices fall airlines cash in.

Delta Air Lines Inc. (NYSE: DAL) is probably a good choice for the top of an airline shortlist. As I did research into it, I realize how scary airline stocks are. Delta actually has a negative book value per share. Still there are things to be happy about. Revenue growth is positive. Cash flow is low, but debt has been declining regularly. Debt falling is a good sign for me. It is not uncommon for airlines to have high debt, because using leverage to upgrade the fleet is more effective. Free cash flow was low last quarter, but overall it has been good recently. Just an interesting note is the difference between Delta's market cap and its enterprise value. Enterprise value can be called the takeover price, and might be considered a true value of the whole business. Though that seems to be endemic among airlines. I have just never seen such a large divergence in any other industry, though I am sure there are others.

Keeping fuel costs under control is absolutely critical to turn a profit. Getting the newest technology is the key to low costs. Delta has been able to keep its fuel costs under control, but that is just one side of the profit story. The other is passengers and revenue. I am not going to make a prediction about when passengers will suddenly flood Delta planes. Use the economy as a gauge. As economic activity goes up, and employment goes up people should travel more. I'd be willing to say that it was simply a rule. More economic activity leads to more flying. Delta has been expanding its routes. There are many other articles talking about Delta's expansions, but listing them all here would serve no purpose.

Second Place, the Far Choice

Some might wonder why I did not choose US Airways Group (NYSE: LCC), which also has positive metrics. It is also considering merging with American Airlines. That is primarily why I do not give US Airways top billing. Mergers are long messy affairs that might take years to materialize the benefits. Mergers might be great for the company that is acquired, but the acquiring company might see a lag. Considering how distressed American is, I doubt US Airways will be able to make an instant hefty profit.

Otherwise, US Airways has positive revenue growth, net income, and free cash flow and seems to be a solid airline. It might be good further down the road, but like I said mergers can take a long time to show solid gains. If you want to have something to hold onto far into the future wait till after the merger occurs or is shot down.

Conclusion

I focused on the two companies that I liked here. The reason I did not include United or Southwest is that I think Southwest is already well-known, and the favorite. If things go badly it has further to fall. United Continental is just too expensive in absolute terms. I prefer a lower price per share for something that makes me as concerned as airlines. Delta covers United Continental as an investment. I would not want to buy more than one airline. US Airways is good if you think the mergers will do well for the company. Between those two there probably is not much reason to go looking for other airlines. The industry tends to rise and fall as a group unless management does not know what it is doing.


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