“If you want to be a millionaire,” Virgin Atlantic founder Richard Branson once mused, “start with a billion dollars and launch a new airline.” The pithy quote sums up the challenges airlines face today, as the industry’s profit margins have been compared to a public charity.
Airline operating costs continue to rise — fuel prices alone have doubled over the past 10 years — all while labor and maintenance costs have increased substantially as well. Last year, the world’s airlines eked out a 1.1% profit margin. Sure, International Air Transport Association Director General Tony Tyler believes that will rise to 1.8% this year … but that still translates to a grim $4 profit per passenger.
“That may be enough for a sandwich, but it is nowhere near the returns that our investors expect,” Tyler said last week. “To keep up with the growing demand for connectivity, over the next 20 years we will need to attract financing to support aircraft orders in the range of $4 trillion to $5 trillion.”
No wonder many commercial airlines are building their future fleets on new cost-efficient aircraft like Boeing’s (BA) 787 Dreamliner and EADS (EADSY) Airbus’ A350, both of which basked in the spotlight of the recent Paris Air Show.
Still, despite the headwinds facing this heavily regulated, capital-intensive industry, opportunities remain for the carriers best-equipped to ride out the turbulence.
After a bruising decade characterized by bankruptcies and epic losses, U.S. airlines’ revenue growth has at least rebounded to pre-recession levels, according to a recent state-of-the industry report by PriceWaterhouseCooper’s.
And the crash of an Asiana Boeing 777 in San Francisco over the weekend notwithstanding, commercial air travel has never been safer. Western-built commercial jets did not experience a single hull loss in 2012 and today’s technologically advanced jetliners also have increased survivability if and when accidents do occur
All in all, U.S. airlines have fared better than many of their counterparts around the world recently. With that in mind, Take a look:
- Strengthening Load Factors. U.S. airlines posted a record 84.3% load factor in March, the most recent month for which data is available, according to the Bureau of Transportation Statistics. Load factors, which measure how well carriers match seat aircraft capacity to demand, are an important metric in determining an airline’s operational efficiency. US Airways (LCC), for example, set a new record-high load factor of 88.2% in June.
- Higher Fee Income. The growth in fee income may be bad for travelers, but it is helping most carriers offset higher fuel and labor costs. U.S. airlines collected $6 billion in 2012 — $2.6 billion in change fees and nearly $3.5 million in baggage fees. Leading the pack was Delta (DAL), which pocketed over $865,000 in baggage and over $778,000 in cancellation/change fees in 2012. United (UAL) came in second with more than $705,000 in baggage and $660,000 in change fees last year.
- Merger-Related Economies of Scale.Airline consolidation has long been viewed as a way to take advantage of economies of scale. Airline mergers make sense because the combined carriers can cut capacity, better control operating costs and gain economies of scale. Delta acquired Northwest Airlines in 2008, Continental merged with United in 2010 and Southwest acquired AirTran in 2011. Plus, US Airways’ merger with American Airlines (AAMRQ) should close within months. Managing the devil in the details is critical, however — UAL struggled mightily with massive systems glitches last year when it attempted to combine its IT systems.
With these factors in mind, which stocks should investors take a ride with?
US Airways is a promising option, to start. The company has been recording strong load factors, and also boasts a compelling valuation. The stock has bounced 74% above its 52-week low last August on the American Airlines deal, but still has a price/earnings-to-growth ratio of just 0.19 and a forward price-to-earnings ratio of less than 6.
United Continental is another solid pick, as the company should largely be over the hump in the integration process and, like Delta, should continue to benefit from ancillary fees.
Investors should be cautious with Southwest, on the other hand, despite its attrative valuation. The company could sruggle slightly in the near-term as it ramps up the integration with AirTran.
As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned securities.