In this week’s Macro Theme, we review our “Slowing Dragon” theme. We began discuss...
Take Off with JETS
05/04/2015 10:00 am EST
Frank Holmes, CEO of US Global Investors, discusses the outlook for the airline sector and his newly launched ETF, the only exchange-traded fund focused on investments in the airline industry.
Steven Halpern: Our very special guest today is Frank Holmes, CEO of US Global Investors, a longstanding leader in global markets and specialized sectors. How are you doing today, Frank?
Frank Holmes: I’m very well, thank you.
Steven Halpern: Today, we’re going to look at a brand-new exchanged-traded fund that you’re in the process of launching called US Global Jets ETF with the great symbol, (JETS), which is focused on the airline sector. Could you tell our listeners about this new fund and the criteria you look at in order to include an airline in the portfolio?
Frank Holmes: Well, I think that’s a great question. There are about 33 names and it’s a smart beta. That means we’re looking at companies that demonstrate higher returns on invested capital and faster growth in revenue per share—which these companies were able to do even with high oil prices—which is quite interesting how they were changing their fee structure—and we look for net profit margins because there appears to be good correlation with stock performance.
Steven Halpern: Now, if I understand correctly, this is the only ETF currently operating that focuses on the airlines, is that correct?
Frank Holmes: That’s correct. There is no other ETF that’s out there. Its 80% US airlines and manufacturers. It’s dominated…over 70% of the portfolio is North American jets.
Boeing is in there for about 3% and then there are 20 names, 1% each, that are foreign. The companies are in a universe of 82 names and it comes down to about 33 names, and globally there is something like 40 names, that comes down to just 20 at 1% each.
Steven Halpern: Now, how important has the decline in oil prices been to the outperformance of this sector in recent years and do you expect low fuel prices to stay in place?
Frank Holmes: I think that oil prices can rally back to $60, $70, but I don’t think it’s going to have a big negative impact on these companies because the majority of them are hedging.
They are hedging 50% of their cost structure and they do a rolling—every month they roll out 8% to 15% of their cost structure—so even when oil was $100 a barrel, this industry had started to turn around and many of these stocks had doubled.
The windfall took place in the last quarter of 2014 when the price of oil fell. What’s going to happen, Steven, this year, is you’re going to see four quarters in a row where cash flow…Deutsche Bank just came out with a report and they said that pretax profit for the first quarter of 2015 is up five-fold from last year. That is, last year it was $700 million, now, for one quarter, it’s going to be $3.5 billion.
Steven Halpern: Now, the actual physical planes themselves have also become more fuel efficient over time. How important is that from a long-term perspective?
Frank Holmes: Very, very important for rising energy prices and I think that’s how they were able to survive when they were going through all the difficulties.
What I found, Steven, is that these airlines—when they went through the restructure and they canceled about 30% of their flights and then they made the seat space smaller and they put more seats in an airplane—so they got a tremendous boost in revenue per flight.
That was a big factor in turning around. The jets were more efficient and the new jets today coming off the Boeing line are even better, so I think, going forth, this is an industry that has lots of cash flow but they’re very disciplined unlike previous times when they would always spend the money like drunken sailors, was the expression, but not this time.
They are very prudent, and in fact, the tipping point last Friday was the CEO of American Airlines said he would take all of his compensation in stock over cash.
Steven Halpern: Now, it’s no surprise that flyers themselves dislike all of the costs being added to airline ticket prices, but you suggest that this ancillary revenue has had a significant impact on profitability. Could you share your thoughts on this?
Frank Holmes: Yes, the concept of charging for a bag, charging you for a heavier bag—I used to have the status of diamond and platinum and if I changed my flight time there was no change, but now they’re charging—so these costs, they call it activity-based accounting and costs, are truly helping them. Another factor is they’re really not trying to undercut each other and grow for the sake of growth.
They are very disciplined on the enterprise value returns on their capital and you’re seeing that as the economy is slowing down in Europe, Delta and American announced that they’re cutting back overseas flights by 3% to maintain their high profit margins.
Steven Halpern: Now, in addition, in your bullish case, you point to increasing travel demand both from an expanding global middle class as well as an increase in US flights to international destinations. Could you expand on that?
Frank Holmes: Sure. Well, one of the most important parts is China and Asia, but in particular, China. When you have 1.4 billion people, 140 million people making $100,000 a year, it gets lost, lost in that sea of 1.4 billion, but they are big travelers.
What was witnessed last year was that Spain made it faster for the Chinese to get a visa to go to Europe. The French had kept it six weeks, the Spaniards a week, and all of a sudden, the Chinese were landing in Spain and luxury goods sales jumped by 25%. They said forget going to Paris where luxury goods sales were down 4%.
You see the importance of that and what’s significant to me is that the US has come up with a 10-year tourist visa for Chinese and you’re seeing properties in New York and LA, San Francisco being snapped up by Chinese coming over and loving America. This is where their second home is. I think that this is going to continue. We’ll see much more travel and it’ll help overall activity.
Steven Halpern: Again, our guest is Frank Holmes. Congratulations on the launch of the US Global Jets ETF. We really appreciate you taking the time today.
Frank Holmes: Thank you.
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