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Airline Stocks: Slash, burn, and buy

Posted March 6, 2008

"An industry-wide decline will present you with some interesting opportunities. The future is filled with consolidation and transformations. Remember, it is not just the airlines worth studying. " – Andrew Snyder 

By Andrew Snyder 

Baltimore (TFN) – In just a few hours, I will grab my bags (which are still packed from the last trip) and hop on a plane on yet one more cross-country jaunt.  I have criss-crossed the country more times than I ever wanted to in the last six months, but all the time away from the office, packed into a soaring aluminum can was not wasted.  A had a lot of time to study the airline industry and watch it evolve.

I just have one question.  How in the world are these companies going to survive? 

The outlook could not be bleaker.  The only time we will be reading about many of today’s current competitors in the future is in the text of MBA case studies.  There are some very real, very tough challenges facing airline executives.

The first of which, of course, is $105 per barrel oil.  Forget the days of hedging, if an airline wants to survive with those prices, it had better be pumping the stuff out of the ground itself. 

Across the pond in London today, British Airways (BAY.L:LSE) announced its 12-month outlook.  I cannot say I am impressed.  Fuel prices are hammering the company’s expectations.  In all, it expects sales to grow by about 4%, to 9.1 billion bounds.  Of that revenue, the airline’s accountants will have to cut a check to its fuel suppliers for 2.5 billion pounds.  Fuel costs will rise by 450 million pounds this year.  It is no wonder Richard Branson is flying around with corn oil in his tanks.

For that price… I’ll walk

The world’s airlines can only pass on the cost of rising fuel to the consumer so much.  After a while, they will begin to price themselves out of the market.  It will become too expensive for the average traveler to take to the skies.  Unfortunately, it is already happening.

Make it part of your daily routine to get a few quotes on your favorite travel route.  It can be quite fun.  Almost every day, the prices are rising.  In fact, I just shelled out over two grand for a set of tickets for my honeymoon. Two days later, the price jumped by $400.

If prices go much higher, most newlyweds will be making domestic post-nuptial vacations.  After all, a good friend of mine (who is happily married for the fourth time) told me, "It’s your honeymoon.  All you need is a bed. Buy your wife a week at the Detroit Super 8.  She’ll never know the difference."  I think I will stick with my beachfront cabana. 

My friend is not known for his apt marriage advice, but he does have a good economic instinct. Airlines are going to have a tough sell as oil prices continue to rise and the economy stutters and misfires. 

For investors, the news is not all that bad.  An industry-wide decline will present you with some interesting opportunities.  The future is filled with consolidation and transformations.  Remember, it is not just the airlines worth studying.  The companies with the products and services that will help keep them afloat are the real goldmines.

For a prime example, turn back to today’s British Airways announcement.  In an effort to improve margins and increase customer satisfaction, the airline is building a huge addition onto the Heathrow Airport, called Terminal 5. It will cost British Airways over 35 million pounds this year in a one-time cost, but will save over 40 million pounds each year in the future. 

Airline stock shakeout

Most airlines are working tirelessly to reduce non-fuel related costs. They have to if they intend to stay in business.  Passenger fares simply cannot make up for rising fuel prices.  In the past six years, British Airlines has slashed nearly two billion pounds of non-fuel costs.  It can be done.

Domestic airlines are having a much tougher time, mainly because of the large amount of national competition.  Fortunately, consolidation and bankruptcy will take care of a lot of the weaklings. 

If you are looking to make money from the airline industry (there is plenty to be made), look at global leaders in low-competition markets, like British Airways.  And of course, look for the firms doing the most-beneficial cost slashing.  These will be the future leaders. 

Across the industry, share prices are plunging.  Do your homework.  Grab some shares on the cheap.  And hold on for a wild ride back to the top.  It will not happen overnight.  But when it happens, you will be glad you stuck around.

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Posted by Andrew Snyder · Filed Under US Stocks and Markets 

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