3 Airlines Earn 5-Star Ratings

04/06/2016 9:00 am EST

Focus: STOCKS

With oil prices remaining low thus far in 2016, we think US airlines are likely to again see record profits this year, following a record year in 2015, asserts J. Corridore, S&P Equity analyst in MarketScope Advisor.

Fuel costs make up about a third of total airline industry costs, and oil prices have fallen by over 65% in the past 24 months. While oil prices have recently crept up, they are still lower than at the end of 2015.

Given our observation that fuel is a more important driver for alpha than unit revenues, we expect the low fuel cost environment to lead to improved equity performance over the next year.

What's more, we think that oil prices are likely to remain lower for longer than many investors and experts are currently thinking.

This is a great cost environment for the US airline industry, in our view. Lets look at some beneficiaries. Here’s a look at three airlines that earn S&P highest 5-star buy rating.

American Air Lines (AAL)

American Airlines is the largest US airline after its merger with US Airways.
It does not hedge at all against changes in oil prices, making it the best pure play US airline to benefit from the current low cost environment.

However, this is a risky strategy, leaving the company exposed to rising oil prices while some peers may be locking in current low prices for the future.

AAL has a very strong domestic and international route network and has been disciplined on its capacity plans.

The company has been generating strong cash from operations and using it to buy back stock as well as to pay a modest dividend. However it has the highest debt levels of US airlines.

Delta Air Lines (DAL)

Delta is the third largest US, but has, in our opinion, done a better job integrating its merger. It has also done a good job attracting business travelers.

The company bought an oil refinery back in 2012, which has turned solidly profitable. This provides the company protection against swings in the cost to refine oil into jet fuel and also provides a large portion of its own jet fuel needs.

The company has been a strong generator of free cash, which is has used to cut debt to under $7.0 billion at the end of 2015 from $15.0 billion at the end of 2010. The company also has a strong buyback program and a dividend yield of 1.1%

JetBlue Airways (JBLU)

JetBlue is a much smaller, largely domestic US airline, though it does have international routes to the Caribbean and Mexico.

The company does not do much hedging against swings in the price of oil, so it does benefit from current low prices.

It is also among the faster growing large US airlines, which is helping drive strong revenue growth.

After a period of underperformance relative to peers, the company replaced its CEO and started making changes meant to improve unit revenues, like charging bag fees and adding seats to its aircraft.

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By J. Corridore, S&P Equity Analyst in MarketScope Advisor

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