Flying a Little Bit Higher

05/14/2009 10:32 am EST

Focus: STOCKS

George Putnam

Editor, The Turnaround Letter

George Putnam, editor of The Turnaround Letter, says US Airways should be able to survive the recession and could bounce back when the economy recovers.

US Airways (NYSE; LCC) began in 1939 as All-American Airways, delivering mail to Western Pennsylvania and the Ohio Valley. From there it grew through acquisitions to be a major national airline.

In 2002, US Airways was driven into bankruptcy by its rapid expansion and heavy debt load, exacerbated by the downturn in air travel following 9/11/2001. The company was rushed through Chapter 11, and came out too soon without solving all of its problems. As a result, it went back into Chapter 11 in 2004 and emerged from that bankruptcy through a merger with America West Airlines in 2005.

Although it took two trips through bankruptcy to accomplish, US Air did significantly reduce its operating costs and improve its balance sheet. Moreover, like many of the domestic airlines, US Air has shed the bad habits that got it (and other airlines) into trouble in the past.

Historically, whenever industry conditions improved a bit, US Air and many of its competitors would expand rapidly to try to grab market share. They would buy new planes, take on debt, and let their costs creep up. Then when the economy weakened, they would not be able to contract fast enough, and bankruptcies would result. This boom and bust cycle characterized the airline industry for much of the last 20 years or so.

This time, however, the airlines generally, and US Air in particular, have been much more disciplined. When conditions began to improve in 2003, the carriers were cautious, did not expand rapidly, and held their costs down. As a result, they were able to deal with the soaring fuel prices of the last few years. And as the economy began to soften, they reacted quickly, and pared back routes and cut costs even further.

Now, with fuel prices down, US Air is well positioned to rebound sharply when air travel begins to pick up again. While its balance sheet cannot be characterized as strong, we believe the company has enough liquidity to get it through all but the most prolonged recession.

In addition, US Air is perhaps less vulnerable than some of its competitors because it has less exposure to international flights, cargo, and premium travel, all of which suffer more during an economic downturn. When travel does begin to pick up again, US Air with its lean cost structure should profit handsomely.

While there is definitely risk in the stock, we believe it is more than outweighed by the significant gain potential in the stock. We recommend buying US Airways stock up to $7. (It closed above $3 Wednesday—Editor.)

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