Devil's Advocate: Airline Stocks
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In all my years of investing, I have never been a fan of airline stocks. With constantly fluctuating fuel prices, frequent labor disputes, enormous debt levels, and high capital costs, I just don't see the risk/reward situation being in my favor. But this got me thinking.
People must buy airline stocks and they must do so for a reason. In the interest of showing another side of the industry, I am going to play devil's advocate with airline stocks. Hopefully this will provide some readers with a fuller understanding of the industry and help them form their own opinions on the future of air travel. Financially of course.
1. Industry Consolidation
One of the ways airlines began merging in the new millennium was by buying each other out of bankruptcy -- after all, there were plenty of airlines to be had. America West purchased bankrupt US Airways and adopted its name to create a somewhat awkward network of hubs. According to some reports, the new US Airways (NYSE: LCC) tried but failed to purchase bankrupt Delta Airlines in 2005. Then Delta (NYSE: DAL), having emerged from bankruptcy, purchased bankrupt Northwest Airlines and became what they advertised as the World's Largest Airline. Republic Airways Holdings (NASDAQ: RJET) then purchased bankrupt Frontier Airlines in 2009 in a transaction valued at a little more than $100 million after fending off a competing offer from Southwest Airlines (NYSE: LUV).
The industry was changed, however, when major carrier United Airlines (NYSE: UAL), made an offer to buy competitor Continental Airlines for 1.05 shares of United stock per Continental share. The deal merged two already major carriers into one gigantic carrier in a merger that fell outside the trends of buying bankrupt airlines. Soon Southwest completed a purchase of low-cost rival Air Tran and even regional affiliate carriers began to merge, with Skywest Airlines (NASDAQ: SKYW) taking control of rival Expressjet in the summer of 2010.
As the airline industry consolidates, prices are likely to increase as the merged entities can cut overcapacity and reduce competition. While this may not be good for airline passengers, it will be good for airline stockholders. Higher fares mean higher profits in an industry that struggles with the high capital costs relating to aircraft purchase, maintenance, fuel, and labor. But increased revenues cannot save the industry alone. The airlines will need to reduce expenses as well.
2. New More Fuel Efficient Planes
Aircraft are well known as fuel guzzlers and the expense ranks only behind labor in cost to airlines. But new aircraft are changing that. The technology of the new Boeing (NYSE: BA) 787 incorporates a new wing shape and the first composite body shell. According to the company, the new 787 should reduce fuel consumption up to 20 percent. Airlines are taking notice and, despite development delays, Boeing is backlogged with orders for the 787 and is considering increasing production.
Airlines are rapidly updating their fleets to slash fuel costs and are purchasing hundreds of new aircraft. Even now-bankrupt American Airlines (Pink Sheets: AAMRQ) has placed an order calling for 460 new planes to be added to its fleet in an effort to replace higher fuel consuming MD-80s. But already the newest planes are being built to allow for the use of alternative fuels as a way to reduce future jet fuel costs.
3. Introduction of Alternative Fuels
United Airlines recently flew a plane powered with algae biofuel produced by Solazyme (NASDAQ: SZYM) in a part PR stunt, part demonstration of the practicality of alternative fuels. Right now Solazyme's fuel is not cost competitive with standard jet fuel, but Solazyme is aiming to reduce the price to $60 to $80 per barrel within the next several years.
But Solazyme needs resources to do this and far-off corporate predictions often take longer than expected. With Solazyme and its fuels still in development, the situation leads to my final point about what is needed to save the airlines.
With Time on Their Side, the Opportunity is There
The airline industry faces great challenges today but will likely face even greater ones in the future. As the economy recovers, fuel prices will rise again driving up a core expense to all airlines. While everything described above will help, what the industry really needs is time. Time to use current profits to buy more efficient planes, time to reduce debt levels, and time to allow alternative fuels to mature.
With the right management now, the industry could survive as a going concern until they put everything together whether through more mergers or more alternative fuels. One thing continues to keep me away from airlines though. If the skies ahead get turbulent and the industry has not prepared, somebody's going to crash and it will be the airlines with their investors on board for the ride.
TulipSpeculator1 has no positions in the stocks mentioned above. The Motley Fool owns shares of Solazyme. Motley Fool newsletter services recommend 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.If you have questions about this post or the Fool’s blog network, click here for information.