Two years ago, leading domestic-based airline firm United Continental Holdings Inc (NYSE:UAL) spent close to $12 billion in aircraft fuel to help 4,500 flights a day fly the friendly skies. For all of 2016, that figure was completely cut in half.
Depressed oil prices may be putting a hurting on energy producers, but are proving a boon for airlines, cruise ships and any transportation business heavily dependent on fueling their fleets with petrol.
UAL stock is no exception, and an improving economy is helping keep its flights near full capacity. The prospects for airline stocks are as great as they have ever been.
Of course, the current tailwinds helping airline stocks could quickly turn into headwinds. United Airlines went bankrupt back in 2002, and the major carriers, including Delta Air Lines, Inc. (NYSE:DAL) (2005) and American Airlines Group Inc (NASDAQ:AAL) (2011). Only Southwest Airlines Co (NYSE:LUV) has succeeded staying out of bankruptcy court since its founding.
Further Upside Ahead for United Airlines?
The wave of bankruptcies resulted in the merging of many legacy firms including Northwest, Continental and U.S. Airways. The industry is now down to four players that control about 80% of the total U.S. market. United, American and Delta each report about $40 billion in annual sales, with Southwest about half at $20 billion.
Another big benefit of bankruptcy for UAL stock is the clearing away of debt. United has successfully paid down $6 billion in indebtedness since 2010. Falling fuel costs have helped it buy back $4 billion of its own stock since 2014. By 2018, it plans to reduce capital expenditures by $1 billion.
The above items are very shareholder friendly and should support airline stocks like United Airlines. Reducing debt lowers financial risk, lower capex leaves more room to buy back stock and debt, and the share repurchases lower shares outstanding, which boosts earnings-per-share. Oh, and UAL stock ended 2016 with $4.3 billion in cash on its balance sheet.
Given the strong financial profile and favorable prospects for the U.S. and global economy, it’s somewhat surprising that United stock trades at a single-digit price-to-earnings ratio. Based off 2018 expectations, the P/E ratio is below 9. It is only 9.8 based off this year’s expectations, and could fall further if the current drop in oil prices holds.
After decades of volatility and waves of bankruptcies, investors appear to be warming to the competitive environment among domestic airlines that favors the leaders. Berkshire Hathaway Inc. (NYSE:BRK.A, NYSE:BRK.B), the giant conglomerate run by legendary investor Warren Buffett, knows a thing or two about picking winning stocks and dominant industries. His firm was recently reported to have built stakes in all four leading airlines.
There is still considerable risk to investing in airline stocks. Geopolitical concerns and safety threats can quickly send leisure stocks on a downward path. Fortunately, there haven’t been any domestic airline tragedies in recent years. Furthermore, the political environment has been relatively friendly for travelers for quite some time now across the globe. There is no reason to see that ending any time soon.
The industry has also fully embraced ancillary fees to stabilize airline ticket ups and downs. Most leading players charge travelers to check baggage, sit in larger and more conveniently situated seats and even eat food while on board. They also offer credit cards with annual fees and entice travelers with airline miles and status-related perks, such as early boarding or upgrades to first class.
Bottom Line on UAL Stock
The only reason I can’t fully embrace UAL stock is that its rivals look like even better investments. Of the top four, United Airlines has the lowest return on equity.
The others also pay a dividend, though all are well below the market dividend yield of closer to 2%. Delta and American also trade at lower forward P/E ratios of 8.1 and 7.6, respectively.
American is my bet for best performer over the next couple of years. It has one of the youngest aircraft fleets, which will help keep maintenance costs low and also indicates they are among the most fuel-efficient compared to rivals. Alaska Air Group, Inc. (NYSE:ALK) trades at a similar forward earnings multiple to United, but it is small and growing rather briskly.
Of course, all bets are off if oil prices rise rapidly, the economy falls into recession, or travelers get spooked by some negative geopolitical event. The list of industry pitfalls is large, but the environment has been as stable as it can be for some time. And as mentioned earlier, airline stocks have even caught the attention of Warren Buffett, or at least his investing protégés.
As of this writing, Ryan Fuhrmann did not hold a position in any of the aforementioned securities.
