Can You Profit From The Market’s Worst Industry?
The Smart Profits Report Issue #528 Tuesday, June 3, 2008
by Marc Lichtenfeld, Senior Analyst, Smart Profits Report It can often be quite a lonely place and the investment crowd may call you all kinds of derogatory names – but when it comes to stock picking, nothing beats the feeling of striking out on your own, going against conventional wisdom and being proved correct. And you know what? The rancor you may receive along the way is actually a good thing – as I’ve discovered at first-hand. When I wrote for TheStreet.com, the more hostility I encountered from readers, it usually meant that I was on the right track. For example, during the height of the real estate boom, I recommended shorting Florida homebuilder and landowner St. Joe Company (NYSE: JOE). You should have seen the reaction I received! I got so much hate mail (and even a few threats) that I was sure it was a slam-dunk. It was. Within months of my column, JOE shares plunged about 50%. I’ve enjoyed many calls like that over my career. But this one could be the most ambitious and optimistic one yet. That’s because if there is one market industry that is so unpopular and so universally hated right now that you’ll probably think I’ve lost my mind to even suggest that it can bounce back. Can you guess what it is? Ladies And Gentlemen… Welcome Aboard As We “Struggle For Survival” I believe you need to keep your eyes on the airlines. There… I said it. I can imagine the incredulous look on your face at the moment – and I can understand why. Let’s deal with the bad news first… The biggest and most obvious pressure right now is oil sitting at $126 a barrefl. Jet fuel has soared 50% since January alone and it doesn’t take a rocket scientist to know that this is disastrous for the long-term health of the industry. On Monday, chief executive of the International Air Transport Association (IATA), Giovanni Bisignani said, “The situation is desperate” and the entire industry is “struggling for survival.” Already, 24 airlines have folded since the start of the year, with Britain’s business class-only airline, Silverjet, becoming the latest victim on May 30. The group says the airline industry’s fuel bill will soar by $40 billion this year to a total of $176 billion. If oil prices edge back towards the record of $135 a couple of weeks ago and continue to trade there, it says that would turn the industry’s $5.6 billion in profit last year into a $6.1 billion loss. However, if oil drops back to $107 a barrel, that loss would “only” be $2.3 billion. But no matter what the price is, the problem is compounded by the weak economy and soaring consumer costs. For sure, the industry is praying that oil is not just taking another temporary breather at the moment on the way to $200 (as some economists believe). That’s the bad news. Now let’s look at the other side… The “Nickel And Diming” Continues… But Planes Are Still Packed Have you flown lately? As I write, I just arrived in Lake Tahoe, where I’m speaking at an investment conference after another long plane ride from Florida. I’ve been on an airplane at least once a month (and usually more) for the past year. But despite all the gloom and doom projections, I can’t remember the last time I had a vacant seat next to me. In fact, I can’t remember ever seeing many empty seats at all. With record high oil prices squeezing profit margins, airlines are figuring out new ways to maximize revenue. Many have imposed passenger fuel surcharges, which are increasing in line with oil prices (just today, British Airways’ latest surcharge increase came into effect – the 11th time the airline has hiked it). Some are now charging for checked bags, meals, even headsets. While this “nickel and diming” approach doesn’t make customers happy, airlines know that many folks have no other choice. Sure, they can take Amtrak if they don’t like it – but that option is often unrealistic. So while others may scoff, I’m going to ask whether it’s possible to profit from the airline industry… A Two-Year Tale Of Woe… But Watch For “Basing” Take a look at the graphic below. It’s a two-year chart of the AMEX Airline Index ($XAL). 
In a word: Awful. And just as I expected back in September. In my September 25, 2007 column, when the index was trading in the mid 40s, I said: “I expect the index to slip back to support at $40. But with oil prices rising in what is usually a quieter period for airlines before the busy holiday season, I wouldn’t be surprised if the index breaks that support level – particularly if the broader stock market (still under some pressure) turns south. In that case, we could see a serious selloff.”
Yep, I’d say so! I certainly don’t suggest that you try to “catch a falling knife” here. However, don’t forget that the market is a forward-looking mechanism. This means that if stocks are rising (or simply stop falling) during a recession, it’s because the market is projecting a recovery. Keep an eye on the XAL chart. Should the index “base” (stop going down and then flatline), or even reverse the downtrend and head higher, the market is likely signaling a recovery. I wouldn’t necessarily get into airline stocks for the long term, as I believe the business model is flawed, but an intermediate-term trade seems quite reasonable once the bleeding stops. And if you’re looking for a couple of the best individual companies (or at least ones whose charts don’t look as abysmal as their peers), check out Alaska Air Group (NYSE: ALK) and Southwest Airlines (NYSE: LUV). Keep them on your radar, as they could be early indicators for the broader sector’s recovery. At that point, you might be able to pick up some bargain basement airline stocks and turn it into a meaningful gain. Buckle Up… The Seat Belt Sign Is On I acknowledge that this call may be a bit early, but I want you to think about it now, so that when the time comes to act, you’ll be ready to pounce and know what to do, rather than considering the idea for the first time. But be warned: Buckle your seatbelts and make sure your seat and tray-table are in the upright and locked position. The airline outlook is likely to be turbulent for a while longer. However, once it stops, the skies may be quite friendly to your portfolio. Hoping your longs go up and your shorts go down. Marc Lichtenfeld
* * * * * * * Today’s Smart Profits Notes: - Looking for the best airline pick? Try the one that “holds the best hand in the industry.” That was Delta Air Lines (NYSE: DAL) CEO Richard Anderson’s boast this morning at the company’s annual shareholder meeting. According to Prime Newswire, Anderson supported this claim by noting the airline’s double-digit top-line growth, expansion of its international services, and the best employees in the industry that helped it achieve one of the best on-time performance records in 2007. And on the sky-high (pun intended) cost of jet fuel, he says the company “faces headwinds,” but is “sticking to the greater strategy of Delta Air Lines.” We’re going out on a limb and guessing that this means “flying planes around the world.” Delta does actually have measures in place to mitigate the cost of jet fuel. This includes reductions in US capacity and a multi-year fuel-hedging portfolio valued at over $1 billion.
- Speaking of capacity cuts, Delta CFO Ed Bastian said today that the company will be forced to do “more pruning” to domestic capacity in an effort to cut costs without laying off employees. He also said that Delta still intends to push forward with its proposed buyout of Northwest Airlines. While some in the industry are concerned that this would mean a sharp cash reduction at a time when airlines desperately need every penny they can get, and with fuel prices climbing, Bastian argues that it’s better to consolidate than stand alone, because it will improve productivity, boost routes, and cut costs. Time will tell. Delta hopes to complete the buyout by the end of the year.
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