From a broad perspective, an investor would think the U.S. Global Jets ETF (NYSEARCA:JETS) would be doing quite well at the moment.
The U.S. economy remains strong, which usually benefits airlines and airline stocks. Worldwide demand for air travel continues to rise. Fuel costs are moderate. The long and destructive history of price wars within the industry appears to have ended.
Berkshire Hathaway (NYSE:BRK.A,NYSE:BRK.B) CEO Warren Buffett long avoided airline stocks for precisely that reason, but reversed field in 2016 and bought stakes in several major U.S. carriers. The news across the board seems positive.
But those positive trends have done close to nothing for airline stocks, and for JETS. JETS actually has declined 3.2% over the past two years, while the S&P 500 has gained more than 18%. Only one of the four major U.S. airline stocks — United Airlines (NYSE:UAL) — has outperformed the index over that stretch, and UAL stock is actually negative over the past twelve months.
At some point, that will change. Airline stocks are among the cheapest in the market, even by the standards of other cyclical stocks similarly at risk in a macroeconomic slowdown. If the economy continues to grow, airline earnings will do the same, and at some point investor confidence toward the group should pick up. The potential combination of higher earnings and higher multiples makes JETS one of the best ETFs to own in 2020.
Everything You Should Know About the JETS ETF
Despite its somewhat confusing title, JETS primarily invests in U.S. equities. (The “U.S. Global” in the name refers to fund sponsor U.S. Global Investors (NASDAQ:GROW), not the geographic dispersion of the fund’s holdings.) The top 13 stocks in the portfolio are all U.S. companies, which comprise 77% of the fund’s assets. The remaining 23% is distributed among 20 overseas holdings, with the U.K.’s Dart Group PLC (OTCMKTS:DRTGF) the largest at just under 2% of assets.
The core of the portfolio, however, is in the four major U.S. airlines: Southwest Airlines (NYSE:LUV), United, Delta Air Lines (NYSE:DAL) and American Airlines Group (NYSE:AAL). Those four stocks account for 44% of the fund. Smaller operators like Spirit Airlines (NYSE:SAVE) and Alaska Air Group (NYSE:ALK) make up most of the remaining domestic assets. Boeing (NYSE:BA) is a holding, but represents just 2.7% of the portfolio, and JETS (somewhat surprisingly) owns no stake in French rival Airbus (OTCMKTS:EADSY).
Thus, JETS is a bet on global airlines more broadly, with a focus on the U.S. airline industry. But to be fair, it’s perhaps not the most efficient bet. JETS is a small fund, with just $52 million in assets under management (a figure that has declined by more than half in recent years). An expense ratio of 0.60% annually is somewhat high. Some investors could replicate much of the fund’s performance via direct ownership of a smaller portfolio focused on its four largest holdings.
That said, the ~23% weighting of overseas assets does help the case for JETS, and offers some welcome diversification. It also creates a bull case in which the fund benefits from positive tailwinds (pardon the pun) boosting both its domestic and foreign holdings.
The Case for Airline Stocks
Again, for U.S. airlines, the argument is that this simply isn’t the industry it once was. Again, price competition is much more rational. Debt levels across the industry have come down markedly, limiting the “boom and bust” cycle that typified past performance. (Southwest, somewhat infamously, is the only major American carrier to have never filed for bankruptcy.)
There have been few, if any, U.S. industries that have destroyed more capital than airlines. It seems that, at least for now, U.S. operators have finally learned their lesson.
Despite that fact, airline stocks are among the cheapest in the market. On average, the four major airlines are trading at 8x earnings; the figure is below 7x backing out LUV stock, which looks downright expensive at 11x 2020 consensus estimates. There’s a case that, like many cyclicals, airline stocks should trade at a discount some ten years into a macroeconomic recovery. But other cyclicals simply aren’t this cheap, and airline stocks themselves have rarely been this cheap.
Meanwhile, there’s a positive trend for airlines worldwide: higher demand for their service. Demand in the developing world is a key reason why Boeing and Airbus have backlogs that extend through the next decade. Airlines will have to spend up to buy new planes, but fuel efficiency should lower operating costs, providing some savings as well. The resolution of the MAX 8 grounding, whatever that resolution might be, too should provide more certainty and allow airlines to more effectively plan going forward.
Even in the U.S., millennials quite clearly prefer experiences like travel to products. And so demographic shifts can help demand as well. The airline industry simply looks healthy at the moment, but its stocks are not valued as such.
That said, there are risks here, and reasons why multiples in the sector are so cheap. For one, there’s the chance that airlines will return to their old competitive ways. It only takes one or two airlines on a handful of routes to trade earnings for market share and resume a potentially destructive pattern.
Obviously, the macro picture is important. Airlines do seem too cheap relative to other cyclical plays — but if the economy does turn in 2020 (or fears of such a turn rise), the entire group will likely go down. Foreign economies aren’t nearly as strong as that of the U.S. (particularly looking to Europe), and JETS would take a hit if its overseas holdings struggle. An investor needs to trust both the economy and the market to even consider JETS, as cheap as its earnings multiple appears to be.
Oil prices can have an impact as well, as they raise costs that airlines either have to eat, pressuring margins, or pass along, potentially impacting demand. And it’s not necessarily guaranteed that those prices will stay low at the same time economic growth stays strong.
And from a broad standpoint, all of the existing benefits combine to create a potential risk. It could be seen as bullish that the operating environment is so benign at the moment, but counter-intuitively, that environment might support a bearish view. After all, almost everything is going right for airlines right now. Looking forward, the news may not always be so rosy.
Oil prices may spike again. The economic picture could darken. Armed conflict or disease could pressure demand. Skeptics — and trading in JETS shows there’s no shortage — would argue that the industry might well be at or near peak profit margins. That alone makes growth going forward more difficult.
Those risks are real. But most of them are present elsewhere in the market. The valuations assigned to JETS and its components are not. If markets continue to rally in 2020, airline stocks should outperform. After all, they have a lot of catching up to do.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.