The Skies Still Look Friendly

2/15/2016


S&P 1500 airline stocks averaged 112% growth in per-share profits for the past 12 months — the second-fastest growth rate among the 102 industries in the index with five or more stocks.

Recent returns suggest investors believe the good times are nearing an end. Shares of S&P 1500 airlines have lost an average of 18% so far in 2016, than the 11% loss suffered by the broader index, as shown in table below. Investor worries generally center on risks that unrestrained capacity growth will eventually crimp airfares and profit margins will contract as oil and labor prices creep higher.

OUTSIZED GROWTH, UNDERSIZED VALUATION
Year-
To-Date
Total Return
(%)
1-Year
Total
Return
(%)
Trailing
P/E Ratio
12-Month
EPS Chg.
(%)
12-Month
Sales Chg.
(%)
S&P 1500 airlines average
(18)
(5)
8
112
2
S&P 1500 Index average
(11)
(13)
19
10
4
Airlines rank (102 industries)
87
27
2
1
67
Note: P/E ratios exclude values above 75 and below zero. Twelve-month change numbers exclude values above 200% and below -75%. Industry rankings are confined to the 102 industries containing five or more stocks. 

Of course, if you believe company executives, those concerns are overblown. Tailwinds provided by lower fuel prices shouldn't ease up any time soon, considering the airlines' projected fuel expenses for the March quarter and the remainder of 2016. 

Pricing remains rational, partly helped by industry consolidation in recent years. And expansion appears disciplined, with most airlines anticipating slower capacity growth in 2016. In January, capacity rose 12.4% for Alaska Air Group ($67; ALK) and 7.8% for Southwest Airlines ($36; LUV). Both airlines reported healthy January traffic, up 10.4% for Alaska Air and up 11.1% for Southwest.

At the same time, rising labor costs present a challenge for airlines. With the exception of Alaska Air, executives expect higher unit costs excluding fuel, defined as cost per available seat mile. Alaska Air expects a 1% decline in 2016, which would mark its seventh straight year of lower unit costs.

The possibility that the U.S. could slip into a recession boosts risk. Airlines are more sensitive to downturns than most other industries, due to their massive fixed costs. Outstanding cash-flow trends in recent years have fortified airlines' balance sheets and should help them weather an economic slump.

Reflecting these risks, the stocks sport compelling valuations. Airlines average the second-lowest trailing P/E ratio of any S&P 1500 industry. They are also cheap compared to their own historical norms. Nine of the 10 stocks in the industry trade at least 13% below their five-year average P/E ratio. Southwest's trailing P/E of 10 hovers near its lowest level in at least 10 years.

Analysts forecast airlines to average 5% profit growth over the next 12 months; Alaska Air is projected to grow 18% and Southwest 22%. Alaska Air is a Focus List Buy and a Long-Term Buy. Southwest Airlines is a Buy and a Long-Term Buy.

OUTLOOK FOR S&P 1500 AIRLINES
Eight of the 10 S&P 1500 Index airlines have reported December-quarter results. From among that group, nearly all of the airlines said they expect slowing capacity growth and lower per-gallon fuel expense in the months or year ahead. Most of the airlines also expect higher unit costs (cost per available seat mile) excluding fuel. Buy-rated stocks are in bold, including JetBlue Airways ($20; JBLU), recommended by sister publication Upside.
---------- Capacity Growth ---------
Fuel Expense (Per Gallon) ** 
Cost Per Available Seat Mile
--------- (Excluding Fuel) ---------
Company (Price; Ticker)
2015
(%)
Est. March
Quarter
Estimated
2016
2015
($)
Est.
March
Quarter
($)
Est.
2016
($)
% Of 2016
Fuel Needs
Hedged
Est. March
Quarter
Estimated
2016
Alaska Air Group
($67; ALK)
10.6
13.50%
8%
1.88
1.25
NA
42
Down 1.5%
Down 1%
Allegiant Travel
($152; ALGT)
25.0
15% to 19%
12% to 16%
1.86
NA
NA
NA
Down 2% to 4%
Flat to up 4%
American Airlines
($37; AAL)
0.8
2.80%
3%
1.72
1.17
1.21
0
Up 1% to 3%
Up 0.5%
to 2.5% 
Delta Air Lines
($43; DAL)
3.0
2% to 3%
0% to 2%
1.90
1.22
NA
NA
Up 5%
NA
Hawaiian Holdings
($34; HA)
3.8
2.5% to
4.5%
2.5% to 5.5%
1.78
1.55
1.40
35
Up 3% to 6%
Up low-
single-digits
JetBlue Airways
($20; JBLU)
9.5
14% to 16%
8.5% to
10.5%
1.93
1.12
NA
5 *
Flat to
down 2%
Flat to up 2%
Southwest Airlines
($36; LUV)
7.2
8%
5% to 6%
1.90
1.70
1.72
20
Up 2%
Up 1%
United Continental
($48; UAL)
2.7
1.5% to
2.5%
1.5% to
2.5%
1.94
1.36
1.27
17
Up 0.5% to 1.5%
Up 0.5%
to 1.5%
* 0% in first half, 10% in second half.  **  Some of the fuel-cost estimates represent the midpoint of ranges provided by the company.

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