Four Ways to Play the Airlines

08/25/2015 9:00 am EST

Focus: STOCKS

Todd Rosenbluth

Senior Director of ETF & Mutual Fund Research, CFRA Research

In the first seven months of 2015, the S&P 1500 Airline index declined 11%, as investors focus on capacity additions with a worrying eye, suggests Todd Rosenbluth of S&P Capital IQ in Marketscope.

However, S&P Capital IQ thinks that airline execs have learned from past costly mistakes on adding too much capacity and forecasts 2015 as a record profitability year, driven by revenue growth and the benefits of lower oil prices.

Years of consolidation, bankruptcies, and capacity adjustments have given the airlines increased pricing power, which has led to rising industry revenues and passenger yields over the past five years.

Meanwhile, much to the displeasure of passengers, airlines have been adding and increasing fees. Bag fees and reservation change fees alone accounted for $4.6 billion in revenues in 2014, up from $3.5 billion in 2012.

From a cost perspective, the US airlines industry consumes about 19-20 billion gallons of jet fuel a year, according to Corridore, so lower oil prices can drive significantly lower costs.

S&P Capital IQ has Strong Buys recommendations on three airline stocks:

Delta Airlines (DAL)

After rising 7% in 2014, revenue growth of 2% in 2015 is likely on a 4%-6% capacity increase, 4%-5% lower yields, and a 1.0 percentage point decline in passenger load factor.

Corridore see fuel costs falling 25%-35% in 2015, as DAL benefits from operating its oil refinery, as well as from lower oil prices, partly offset by losses on hedging contracts entered into at higher fuel prices.

S&P Capital IQ sees 2015 operating EPS of $4.41, reflecting potential 40% growth over 2014 adjusted EPS of $3.16. For 2016, we forecast 25% growth to $5.50.

JetBlue (JBLU)

After a 7% increase in 2014, S&P Capital IQ forecasts revenues rising 11% in 2015 and 10% in 2016. For 2015, we see 8% capacity growth with a 1% rise in yields and a 1% increase in passenger load factor.

Recent slot additions at Reagan National Airport divested by AAL should help re-accelerate revenue growth, we think.

We see 2015 EPS of $1.80 rising to $2.04 in 2016, comparing favorably to 2014 operating EPS of $0.70.

American Airlines (AAL)

Corridore upgraded the recommendation on AAL to strong buy in late July following second quarter results. Based on S&P Capital IQ estimates, AAL is trading at a 30% discount to the peer group average, which we think is unwarranted.

AAL has seen a relatively smooth merger integration and its full participation in lower oil prices is due to its strategy to not hedge oil. While revenues are projected to decline in 2015, they are expected to rise in 2016.

US Global Jets (JETS)

We also give an overweigh rating to US Jets. The ETF was launched in April, providing investors with diversified way to gain exposure to the improving fundamentals of the airline industry. AAL, DAL, and JBLU are all top-10 holdings.

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