Airlines May Fly High Despite Turbulence

04/14/2009 11:00 am EST

Focus: STOCKS

Michael Brush

Columnist, MSN Money

Michael Brush, contributor to MSN Money, says airlines are in surprisingly good shape and some stocks look attractive on any weakness.

With the clouds of recession so dark, what's keeping airlines aloft?

The short answer: energy prices. What looked like the bane of the sector last summer—skyrocketing fuel costs—has actually turned out to be a saving grace. Despite a continuing decline in the number of flights taken by vacationers and business travelers, most airline companies are still expected to be profitable this year.

Some investors even consider the recent slide in the stock prices of Delta Air Lines (NYSE: DAL), Continental Airlines (NYSE: CAL), and other carriers to be a buying opportunity.

High energy prices forced airlines to cut capacity sharply throughout 2008. That gave them a jump on cost-cutting ahead of the severe pullback in consumer spending that followed later in the year. And as the economic pullback got worse, energy prices came down sharply, helping airlines further.

"The industry is actually in pretty good shape," says Mo Garfinkle, an airline-sector strategist with GCW Consulting. "They can actually weather the recession storm reasonably well, as long as it isn't a prolonged recession."

To be sure, airline stocks have dropped as much as 75% in the past two years. Earnings are down sharply because cost-cutting hasn't kept up with fare reductions. The coming release of March and April traffic data and lousy first-quarter earnings could hit airline stocks, Stifel Nicolaus analyst Hunter Keay cautions.

[But] investors who are patient and don't mind a little risk will probably do well to pick up airline stocks if the broader market pulls back in coming weeks. (Delta closed near $7.50 Monday, Continental at around $13, AMR below $5, and UAL under $7—Editor.)

Delta, with $4.5 billion in cash, clearly stands out for solid financial strength. "For those willing to take a 'buy the survivors' approach, we view Delta as the most sound investment," Keay says. Delta also has plenty of room to cut capacity and costs in its merger with Northwest. Morningstar (Nasdaq: MORN) analyst Basili Alukos believes the merger could ultimately bring $2 billion in cost savings.

Likewise, Continental looks strong, with cash of about $2.6 billion. "Should the sector plunge into a liquidity crisis, we have high conviction Continental would be a survivor," Keay says

The weaker airlines to avoid are AMR (NYSE: AMR), which runs American Airlines, and UAL (Nasdaq: UAUA), which operates United Airlines. No one is predicting they will go bankrupt. But they look more vulnerable.

"AMR faces the most risk among companies in our coverage because of $1.9 billion of expected debt and capital lease payments and $1.6 billion in (capital spending) due this year,” Keay says.

And once these stocks do recover, take your profits, because they are notoriously cyclical—meaning they go up and down along with the twists and turns in the economy. (Delta closed near $7.50 Monday, Continental at around $13, AMR below $5, and UAL under $7—Editor.)

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