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Can Airline Stocks Fly Higher?

The sector seems to have already priced in a turnaround


As the airline sector celebrated a rebound in passenger load factors and return to profitability in 2010, investors are now asking “How much better can it get?” Despite a flurry of positive earnings news from United Continental (NYSE:UAL) and US Airways (NYSE:LCC) on Wednesday, the short-term answer is likely to be “Not much”.

Here’s why: Stock prices already have risen dramatically over the past year, reflecting the post-recession rebound in air travel — particularly in the profitable business travel segment. 

Industry consolidation also has fueled recent gains as well-managed mergers help air carriers achieve greater economies of scale in their operations. Delta Air Lines (NYSE:DAL) kicked off the most recent wave with its Northwest merger in 2008.  Last fall, United Airlines agreed to merge with Continental, and Southwest Airlines (NYSE:LUV) announced plans last fall to join with low-cost carrier AirTran (NYSE:AAI)

According to the International Air Transport Association, the airline industry lost nearly $27 billion during 2008 and 2009.  But airlines then rebounded to post profits of some $15 billion in 2010. In October 2010 the number of traveling air passengers was up a whopping 5.6% from a year earlier – the largest percentage gain since the summer of 2007.

But the market already has reacted to the turnaround.  Over the past year, the ARCA Airline Index has risen from a February low of $30.91 to an October high of $50.66.  And worries that skyrocketing fuel costs will devour airline profits in 2011 have caused the index to slip below $48 so far this month. 

The IATA predicts that while the airline industry will end 2011 in the black, rising fuel costs will cause industry profits to slip into the $9.1 billion range this year.  So while the outlook for airline stocks is positive in the long term, it will be difficult for share prices to continue the past year’s large gains over the short term.

Nevertheless, airline executives intend to do what they can to offset the impact of out-of-control factors like fuel prices.  United Continental made clear on Wednesday that it will cancel flights and use smaller aircraft to offset fuel increases.

“We’re carefully evaluating our summer, fall, and winter schedules to ensure that we have the appropriate capacity to allow us to recover the higher cost of doing business,” United Continental CEO Jeff Smisek said in the company’s earnings conference call on Wednesday.

US Airways’ CFO Derek Kerr echoed those sentiments on his company’s earnings call Wednesday.  “We’re happy that the industry has restructured enough that it can actually be profitable with oil above $90,” he said, adding that US Airways likely would reduce capacity if oil prices remain at those levels.  US Air posted its first profitable quarter since 2006 – reason enough for celebration. However, the party in airline stocks may be over for now.

Article printed from InvestorPlace Media,

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