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Airline Industry

Airline industry enjoying surprising upswing

Brent Jang  Aug 17, 2010

From rising traffic to increased fares, the airline industry is enjoying a surprising upswing in the face of lingering doubt about the strength of the economic recovery.

Only 18 months ago, global carriers were struggling mightily in a sector better known for spectacular flameouts than solid financial performance. But a first-half jump in both business and economy travellers has improved the picture.

In the first half of 2010, premium travel surged globally by 11.9 per cent from the same period last year, while economy bookings rose 6.3 per cent, the International Air Transport Association said Monday.

While IATA acknowledged that “there are signs that this very strong post-recession rebound in travel may be slowing” in the second half of 2010, the group representing global carriers said it is optimistic there will still be buoyant economic growth and impressive gains in world trade, which help fuel corporate travel.

Global airfares have rebounded from their recessionary lows, but remain roughly 15 per cent below their prerecession peaks. “Routes linked to Asian markets, which represent 30 per cent of premium revenues, continued to show the strongest development, despite a deceleration of economic activity in some countries in the region,” IATA said.

For investors, it has been a rewarding ride. The NYSE Arca Airline Index has more than tripled since hitting a recessionary low in March, 2009. The index, which includes U.S. and overseas carriers, climbed 2.4 per cent on Monday, spurred by the announcement late Friday that TAM Airlines of Brazil will be merging with Chile’s LAN Airlines.

“Airlines are in a cyclical industry, and like anything cyclical, there are peaks and valleys in valuations,” PI Financial Corp. analyst Chris Murray said in an interview. “The first thing you need to have in mind when you’re thinking about investing, especially in airline stocks, is you should have some reasonable comfort in your macro-view of the world.”

For risk-tolerant investors wondering whether to climb aboard the airline bandwagon, it means placing a bet on a prolonged economic rebound. “We’re in a recovery, though it’s continuing to be slow,” Mr. Murray cautioned.

Load factors, or the proportion of seats filled by paying customers, have increased. North American carriers cite their improved load factor as one of keys behind the return to financial health, though fuel prices linger as a concern.

“Airlines are high fixed-cost operations. Once you’ve covered your fixed costs, the incremental variable costs are low,” Mr. Murray said. Still, he offers this reminder: “Even small changes in operating metrics can create absolutely immense changes in earnings.”

At Montreal-based Air Canada for instance, every one-percentage-point change in load factor translates into an impact on operating profit of $94-million, says Mr. Murray, who has a “speculative buy” on Air Canada, with a 52-week target price of $4.75. He rates WestJet as a “buy” with “above average” risk, placing a target of $17 on the Calgary-based carrier.

WestJet shares closed unchanged at $12.05 on Monday, while Air Canada class B shares finished up 1 cent at $2.21.

Other analysts also see attractive returns for investors who can handle the turbulence of Canada’s two largest airlines. RBC Dominion Securities Inc. analyst Walter Spracklin has a 52-week price target of $5 for Air Canada and $16 for WestJet.

Raymond James Ltd. analyst Ben Cherniavsky’s targets are $3.75 for Air Canada and $15 for WestJet. “While we maintain some reservations about WestJet’s growth plans and cannot say that our expectations are being fully met, we believe that things are generally going in the right direction as industry conditions continue to improve,” he said in a research note.

For those queasy about picking individual airline stocks, there is the opportunity to play the airline sector’s ascent through the Claymore/NYSE Arca Airline exchange-traded fund. Launched early last year, the ETF hit a record low of $13.45 in March of 2009, but is up 154 per cent since then to $34.22, despite sliding 10 per cent since its mid-April peak.

The ETF had a geographic weighting of 71.75 per cent on major U.S. carriers at the end of June, led by UAL Corp.’s United Airlines Inc., Southwest Airlines Co. and Delta Air Lines Inc.

Morgan Stanley analyst William Greene said U.S. airlines appear to be disciplined so far in managing seat capacity, noting that executives at Atlanta-based Delta have reiterated their confidence in gradual gains in revenue.

“The airline industry is firmly in the recovery phase of this up-cycle, historically an attractive period in which to build longer-term positions,” Mr. Greene said in a research note.

Airline industry enjoying surprising upswing
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