The stock market is a forward-looking instrument. It anticipates macro- and microeconomic factors and combines it all together to determine the price of a stock. In the case of the airline industry, the overriding factor in current valuations is the price of oil.
So dependent on jet fuel to their business, airlines lose money as the price of oil goes up. That is to the extent that pricing cannot be passed along to consumers. With oil prices flirting with $100 per barrel once again, airline stocks are being sold en masse.
Already down for the year, this latest plunge takes prices to ridiculous levels. After the first quarter of the year, names like Delta Air Lines (NYSE:DAL), American Airlines’ AMR Corp. (NYSE:AMR) and United Continental Holdings (NYSE:UAL) were down double digits. In stark contrast to the overall market, which was slightly higher at the time, investors clearly were skeptical about airlines’ ability to pass along higher oil prices to customers.
Funny, though, how the market can be wrong. For example: Delta traded for around $9 per share when it released results that were expected to show the deleterious impact of higher oil prices. Oops! It turns out Delta navigated the higher prices just fine. Shares jumped 20% in the few days of trading after releasing results.
Fast-forward to the end of the second quarter, and sure enough, oil prices, though drifting lower, still were perilously close to $100. Bad, bad, bad, says Mr. Market, and shares of Delta floated back down to $9 per share. In July, the selling continued, and today Delta trades for just more than $8 per share.
I would view the excessive selling as an opportunity. Airline stocks are dirt cheap. If the only reason for the decline is oil prices, do you think the market is taking into account the possibility of lower oil prices? It would hardly seem so, and yet some economists see a significant drop in oil prices coming in the near future based on fundamentals of the oil market.
If such forecasts are correct, airline stocks likely will move higher, just as Delta did when it reported results for the first quarter of the year. Recently, AMR reported a loss in the second quarter of 85 cents per share. That exceeded the expected loss of 75 cents per share.
AMR blamed the bigger loss on higher oil prices, just as the market was predicting. So why, then, was the stock up after the report was released? It turns out AMR was placing a huge order for new aircraft. Doing so suggested that underneath the pressure of higher jet fuel is a healthy business. You do not order new aircraft if you don’t think business will support such an investment.
The gains in AMR shares were short-lived. After moving higher in the day after it released earnings, shares subsequently traded down hard. The selling once again was a direct result of the speculation that higher jet fuel costs would result in lower profits or even losses for the airline sector.
US Airways (NYSE:LCC) reported earnings Thursday that further solidified the bearish argument. The company generated a profit of 49 cents per share in the quarter, missing estimates of 61 cents by a wide margin. Interestingly, US Airways noted the impact of higher jet fuel prices, but it did say that it was able to pass along some of that expense to customers in the form of higher surcharges. No matter to short-term sellers, but I would view such a state to be positive for the stock.
For the full year, analysts expect US Airways to make 67 cents per share this year. In 2012, that number more than doubles to $1.68. You can buy US Airways today for just 10 times current-year estimates. Even if you assume the company misses badly on results in 2012 – say they make $1 per share – the stock still would trade for only seven times that amount with earnings growth of 50%.
US Airways and other airline stocks are a steal at these prices.
