While debt levels remain high, several airlines are reducing leverage. Delta has cut net debt by $3.2 billion, to $13.8 billion, in recent years. In the second quarter alone, it slashed its obligations by $700 million, and its goal is to trim debt to $10 billion.
One big positive: Airlines have a lot of cash. At the end of the second quarter, United Continental had more than $8 billion; AMR, $5.2 billion; and Delta, $3.8 billion. JPMorgan analyst Jamie Baker noted recently that airlines' enterprise values (stock market value, plus net debt) had returned to 2009 lows. Equity values may be higher, but debt levels are down. Baker wrote that while he was "frightened" for the industry in 2009, during the financial crisis, he's "merely concerned" now, arguing that the "risk-reward appears highly attractive" for investors willing to take a mildly optimistic industry view. The combined market value of the seven major carriers is only $25 billion, while their combined enterprise value exceeds $80 billion.
The bear case is that airlines are too unpredictable and too vulnerable to changes in demand and the price of jet fuel, which may cost the industry $54 billion this year, up from $39 billion in 2010. Every $1 move in crude affects industry profits by $400 million. And, unfortunately for airlines, jet-fuel costs are based on international oil prices, recently above $110 a barrel, not U.S. benchmark crude, around $90.
Trailing the market
The volatile industry, which has suffered multiple bankruptcies in the past decade, has flown well below the Standard & Poor's 500 Index ($INX).
Many investors hate industries like airlines because of their strong unions; it's hard to get labor concessions in bad times, and the unions tend to push for a greater share of profits in good times. However, airlines probably are now managed better than ever, remaining profitable despite a weak economy and high fuel costs -- something unthinkable a few years ago. And most are determined to deal with their unions.
Despite complaints from travelers, the industry delivers a valuable service at a price that's usually reasonable. The average domestic round-trip ticket cost $316 in 2010, little changed over a decade. In fact, adjusted for inflation, ticket prices are down more than 40% since airline deregulation took hold in 1979. Travelers usually can still fly coast to coast for $500 or less, round-trip.
Airlines have shrewdly gotten creative about charging for things that formerly were free, such as transporting baggage and providing meals. Bag-check fees alone totaled $3.4 billion last year, up from $500 million in 2007. So-called change fees to modify reservations generated an additional $2.3 billion last year. Pay American a fee, and you can get expedited clearance through security and access to airport lounges. United and others offer seats with extra legroom in coach for an additional charge.
Airlines reaped $5.7 billion last year from fees on checked baggage and reservation changes. These fees are helping airlines offset much higher fuel costs this year.
Starting from the top
A brief look at seven airlines, ranked in order of their appeal:
United Continental: It's emerging as the class of the industry, after the 2010 merger of the two carriers created the largest domestic airline, with projected revenue of $37 billion this year.
Even without much financial benefit from the deal, the carrier had an operating margin of almost 9% in the second quarter, behind only Alaska Air. The merger savings ultimately could total $1 billion a year, hinging in part on greater cooperation from United's historically difficult unions. That's a key risk. At around $18, the stock recently traded at under six times projected 2011 profit of $3.30 a share, and just four times 2012's estimated $4.75. Deutsche Bank's Linenberg sees United generating $2.1 billion of free cash this year. His 12-month price target is $31.
Delta: That it has largely completed its integration with Northwest has helped Delta greatly. The stock, recently around $7, is a favorite of Maxim Group's Neidl, who wrote that it's "reaping the benefits of its new powerful route system and worldwide alliance." The consensus earnings estimate of nearly $1 a share for 2011 and $1.75 for 2012 "could be light" if the economy avoids recession and global oil prices hold. Linenberg carries a price target of $16.
Alaska Air: It has been the top-performing domestic airline stock this year, mostly because 2011 profit estimates have increased, and now stand at $7.64 a share. Alaska Air had its fifth straight record quarterly profit in the June period, and it's paying down debt and buying back small amounts of stock. Analysts credit veteran management, good labor relations, an underappreciated West Coast network and popularity with leisure travelers. Much of its growth is coming from West Coast-to-Hawaii routes, with the company avoiding competitive San Francisco and Los Angeles airports and flying such routes as San Diego to Honolulu. Linenberg's target: $80.
JetBlue: An investor favorite after its hot 2002 initial public offering, JetBlue now sells for about half its IPO price and a fraction its 2003 peak. It continues to grow, largely in Boston and the Caribbean, but its margins are under pressure, as are its profit estimates. Analysts now expect the airline to earn about 20 cents a share this year, versus 44 cents at the start of this year and 60 cents when Barron's wrote favorably about the company a year ago.
The stock may have bottomed. JetBlue is trading below its book value of $6 share, has a good balance sheet, a young jetliner fleet and a strong reputation among leisure travelers who like its free satellite TV, ample legroom, comfortable leather seats and employees' irreverent attitude.
Southwest: The longtime industry financial leader has seen its status erode, as rivals narrow cost advantages. After second-quarter profit missed Street estimates, analysts cut their 2011 forecasts to an average of 36 cents a share, from 60 cents, and also trimmed 2012 projections. Southwest stock, recently at about $8, may find support now, because it trades below its book value, about $9 a share. The airline has both a strong management and balance sheet, as well as fuel hedges that should offer protection if oil prices rise. While Delta and United Continental may be better values, Southwest probably would have the most staying power in an extended downturn.
US Airways: It has the worst route system of any major carrier, the weakest financial performance except for AMR, and virtually no fuel hedges. The airline is seeking to improve its competitive position by swapping gates with Delta to secure a larger presence at Reagan National, near Washington, in return for slots at New York's LaGuardia. Profit estimates for 2011 and 2012 came down after second-quarter results fell short of expectations. US Airways is expected to operate around break-even this year and earn just over $1 per share in 2012. There's plenty of upside in the stock if fuel prices drop and profits turn higher.
AMR: The stock, recently around $3.50, amounts to an option on the carrier's ability to return to profitability. AMR lost 85 cents a share from operations in the second quarter, by far the industry's worst performance, and is expected to lose almost $4 a share this year. Management is betting on a turnaround keyed to new airplanes; the company has announced that it will order 460 new Boeing (BA, news) and Airbus jets over the summer. It also is seeking labor concessions and may spin off its regional-jet business. While justifiably proud of being the only major carrier to avoid bankruptcy, AMR couldn't restructure labor agreements, as the bankruptcy crowd did.
Maxim Group's Neidl writes that AMR is "only for those" who believe that it can make major changes and return to consistent profitability. If current trends continue, AMR may be forced into a financial restructuring, which would be bad news for shareholders.
Given the risks in the airline industry, investors probably should stick to its strongest, most profitable members. Right now, those are United Continental, Delta, Alaska Air, Southwest and JetBlue.
