02/04/2005 12:00 am EST


Bernie Schaeffer

Chairman and CEO, Schaeffer's Investment Research

Bernie Schaeffer is no stanger to out-of-favor picks. In fact, much of his strategy is based on contrary analysis. Here, he looks at the fundamental and technical backdrop of the airline sector, and despite its out-of-favor status, finds select opportunities in the area.

"One sector I've discovered a few opportunities in of late is the airline group. Yes, you heard me correctly. The airline group, ferociously lambasted due to rising fuel costs, lowered fares, and narrowly avoided bankruptcy proceedings, is a spot for potential profitability. Why? In part, because of the ferocious lambasting. It will take only the most minor nugget of good news (or the simple lack of horrendous news) to surprise the skeptics. Wall Street is one of the primary offenders when it comes to writing off the airline group as a lost cause. Of the 28 sectors that we follow, airlines have the highest percentage of ‘sell’ ratings. Less than 40% of the 91 analyst ratings on airline stocks are ‘buys.’ This is the lowest ‘buy’ percentage for the airline group since we began tracking this data in April 2003.

"While investors struggle to fly through this turbulence, the AMEX Airline Index ($US:XAL.X ) has rallied more than 95% off its March 2003 low (despite a rough start to 2005), and yet analysts are more negative now than at any point during the past two years. And as US airlines continue to post positive load factor and traffic numbers, some of these bears may change their tune. Options players have also gathered on the bearish side with regard to the airline sector. While some skittishness toward this sector is certainly understandable, there should also be room for some positive thinking.

"Let's turn to one of my current favorites in the airline group, Northwest Airlines (NWAC NASDAQ). The stock enjoyed huge volume during the first two weeks of January, on par with total monthly volume in previous months. On the sentiment side, NWAC boasts a short-interest ratio of 12 times the stock's average daily volume. What's more, nearly 32% of its available float is sold on the short side. That's what I call ‘low expectations.’Meanwhile, I also own Delta Air Lines (DAL NYSE), which recently shook up the airline sector when it announced sweeping fare cuts. The company continues to fight back for market share after it narrowly avoided filing for bankruptcy protection in the fall when its pilots agreed to cut their salaries by a third. Sentiment remains bleak, with swarms of investors betting against the security. Short interest for DAL sits at a hefty 50.4 million shares, or 39% of the stock's total float. At almost eight times the stock's average daily trading volume, the security could see some short-covering support. Further, options players have loaded up on DAL puts."

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