Prepare for takeoff! Airline stocks are hotSeptember 10, 2013: 12:54 PM ET
The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, Abbott Laboratories and AbbVie, La Monica does not own positions in any individual stocks.
When you think of the big airlines, what comes to mind? Poor customer service? Late departures and arrivals? Excessive fees? Bankruptcies?
That's all true. But investors are looking past all that. They see money. And lots of it.
Airline stocks are among the best performers in the red hot stock market this year. And they may still have some room to run. (Or is it taxi?)
Delta (DAL), which is getting added to the S&P 500 index at the end of trading Tuesday, has surged 90%. To put that in perspective, Delta has been a better stock this year than sexier dot-coms like Facebook (FB), Google (GOOG), Yahoo (YHOO) and Amazon (AMZN).
Southwest (LUV) and United Continental (UAL) are up more than 30%. And so are shares of US Airways (LCC) -- even though there are some concerns about what might happen to the stock if the government is successful in killing US Air's plans to merge with bankrupt American.
Speaking of American, if you were bold enough to roll the dice with the company's pink sheet-listed (AAMRQ) shares, you would be happier than someone who just joined the mile high club. AAMRQ has surged nearly 330% so far this year! (American's AMR stock on the NYSE was delisted in 2012 after the company filed for Chapter 11.)
The only major airline to lag the rally? JetBlue (JBLU). Its shares are up only 13% this year.
What gives? Jim Corridore, an analyst with S&P Capital IQ, said that the series of mergers in the industry over the past few years has made the remaining airlines more efficient and profitable.
Most of the major carriers have cut capacity. And the days of ridiculous price wars seem to be gone for good. And while that's bad news for travelers, it's great for shareholders.
"The airline sector is less risky, It's more appropriate for investors and not gamblers," Corridore said. "The companies are managing for profitability, and not market share."
The improving U.S. economy is clearly helping the group as well.
Helane Becker, an analyst with Cowen & Co., wrote in a recent report that she expects strong traffic trends for the whole group to continue. Becker also wrote that she thinks US Air and American will eventually reach a compromise with the government that could allow the merger to go through.
If that happens, it's a plus for the entire sector since it would further reduce capacity and probably keep the industry from needing to engage in big fare cuts that would destroy profit margins. Again. That's turbulent news for consumers. But it's the equivalent of a clear, blue sky to investors.
Still, are any of the stocks still a good value considering that nearly every major airline has outperformed the broader market? Corridore and Becker both say yes.
Many analysts still look at an esoteric measure of valuation known as enterprise value to EBITDAR (earnings before depreciation, interest, debt, amortization and rent) since that gives investors an apples-to-apples comparison during times when the airlines are reporting net losses. But we're not in one of those bust cycles right now.
Because the airlines have done a better job of consistently generating profits, investors can actually look at traditional price-to-earnings ratios to find bargains.
On that basis, US Air is the cheapest -- probably due to lingering concerns about what will happen to the stock if it has to abandon the American deal. Shares trade for just 5.5 times 2013 earnings estimates, according to FactSet Research. The average for the group is 10.
That's one key reason why Corridore said US Air is his top pick in the group. But it's also the cheapest when you look at EV/EBITDAR. It trades for less than 3 times estimates for this year. The average for the industry is 5.
Delta also looks like a bargain, trading at just 8 times earnings forecasts. United and Spirit are a little pricier, trading at 10 and 15 times earnings estimates for this year, respectively. But Becker wrote that both of those stocks are top picks. Earnings are expected to grow dramatically this year and next for each airline. Becker likes the "dominant" global network of United and notes that Spirit has no debt on its balance sheet.
Still, can investors really own airline stocks without having to worry? No. Becker noted that if oil prices continue to rise due to worries about tension in Syria and the rest of the Middle East, that could lead to higher jet fuel prices and lower profits.
And Corridore conceded that there's always the risk of airlines lapsing into bad habits.
"This is still a risky sector. They are never going to be buy-and-hold stocks you can put away for a period of years. You have to monitor them constantly," he said.
Nonetheless, that's a huge improvement from a few years ago. It used to be that Southwest was the only airline that you could count on to earn money. Nowadays, airline profits are just about as common as, well, delays on the tarmac.