Five Airline Operators to Own Now

With crude trading near prices not seen in over a decade and the U.S. economy strong enough to tolerate a rate hike, many airlines are fantastically profitable. Given that the smart money does exhaustive research and hires only the best and brightest, we take advantage of the smart money’s work and examine hedge funds’ top airline picks, such as Delta Air Lines, Inc. (NYSE:DAL), American Airlines Group Inc (NASDAQ:AAL), United Continental Holdings Inc (NYSE:UAL), Southwest Airlines Co (NYSE:LUV), and JetBlue Airways Corporation (NASDAQ:JBLU), many of which trade at reasonable valuations and have substantial upside.

Given that Insider Monkey has done a lot of research into what the smart money likes and doesn’t like, let’s also analyze relevant hedge fund sentiment toward the stocks. But why do we track hedge fund activity? From one point of view we can argue that hedge funds are consistently underperforming when it comes to net returns over the last three years, when compared to the S&P 500. But that doesn’t mean that we should completely neglect their activity. There are various reasons behind the low hedge fund returns. Our research indicated that hedge funds’ long positions actually beat the market. In our back-tests covering the 1999-2012 period hedge funds’ top small-cap stocks edged the S&P 500 index by double digits annually. The 15 most popular small-cap stock picks among hedge funds also bested passive index funds by around 53 percentage points over the 36 month period beginning from September 2012 (see the details here).

#5 JetBlue Airways Corporation (NASDAQ:JBLU)

– Number of Hedge Fund Holders (as of September 30): 42
– Total Value of Hedge Fund Holdings (as of September 30): $714.19 million
– Hedge Fund Holdings as Percent of Float (as of September 30): 8.80%

Shares of JetBlue Airways Corporation (NASDAQ:JBLU) have been red-hot this year, with the stock of the regional airline up by 46% year-to-date. Investors are optimistic as the company has either met or exceeded analyst earnings estimates every quarter so far this year. Although JetBlue expects fourth quarter PRASM to be down 2%-3% year-over-year, given the strong U.S. wage growth and falling crude prices, the airline will likely continue to report strong earnings for the quarters to come. David Tepper’s Appaloosa Management LP owned 4.49 million shares at the end of September.

#4 Southwest Airlines Co (NYSE:LUV)

– Number of Hedge Fund Holders (as of September 30): 54
– Total Value of Hedge Fund Holdings (as of September 30): $2.54 billion
– Hedge Fund Holdings as Percent of Float (as of September 30): 10.10%

On December 8, Southwest Airlines Co (NYSE:LUV) shares took a major hit after the discount airline reported revenue passenger miles increasing by 13.9% year-over-year to 9.7 billion in November and capacity rising by 9.7% to 11.7 billion available seat miles for the month. The company also reported that it expects fourth quarter revenue per available seat mile to be flat-to-down by 1.0 percentage points due to cheaper fares. Rising industry capacity is always a concern for investors as excess capacity historically gets airlines in trouble when the economy turns. Cheaper fares is also a no-no in investors’ books, as cheaper prices typically lead to lower margins and weaker returns on capital. With that said, Southwest Airlines might not have much further to fall, as its shares trade for a reasonable 10.96 times forward earnings.

#3 United Continental Holdings Inc (NYSE:UAL)

– Number of Hedge Fund Holders (as of September 30): 70
– Total Value of Hedge Fund Holdings (as of September 30): $2.97 billion
– Hedge Fund Holdings as Percent of Float (as of September 30): 14.80%

The sell side is pretty bullish on United Continental Holdings Inc (NYSE:UAL), as 15 analysts have ‘Buy’ ratings, two have ‘Strong Buy’ ratings, and two have ‘Hold’ ratings. No analyst has a ‘Sell’ rating. Overall, the 19 analysts have an average target price of $78.92 among them, giving United Continental more than 36% upside. Among the 70 elite funds that are long the stock include Cliff Asness’ AQR Capital Management, which increased its position by 22% to 4.1 million shares at the end of the third quarter, and Leon Cooperman’s Omega Advisors which trimmed its holding by just 1% to 2.79 million shares during the third quarter.

#2 American Airlines Group Inc (NASDAQ:AAL)

– Number of Hedge Fund Holders (as of September 30): 77
– Total Value of Hedge Fund Holdings (as of September 30): $1.82 billion
– Hedge Fund Holdings as Percent of Float (as of September 30): 7.00%

American Airlines Group Inc (NASDAQ:AAL) reported record profits for its third quarter, earning $2.77 per share and exceeding analyst estimates by $0.05 per share. Given that American Airlines is one of the few big airlines that doesn’t hedge, it will remain one of the primary beneficiaries of the ‘lower for longer’ crude prices. Shareholders will benefit as well because management is using the company’s profits to buy back shares. American Airlines repurchased $1.56 billion worth of stock in the third quarter and the board has authorized a new $2 billion repurchase program to be completed by the end of 2016. George Soros’ Soros Fund Management was long 1.92 million shares at the end of the third quarter.

#1 Delta Air Lines, Inc. (NYSE:DAL)

– Number of Hedge Fund Holders (as of September 30): 109
– Total Value of Hedge Fund Holdings (as of September 30): $7.32 billion
– Hedge Fund Holdings as Percent of Float (as of September 30): 20.50%

With 109 funds long the stock at the end of September, Delta Air Lines, Inc. (NYSE:DAL) is somewhat of a consensus hedge favorite. Given Delta’s forward P/E of 8.81 and the airline’s solid fourth quarter guidance of operating margin of between 16% and 18%, it’s not hard to see why the smart money loves the stock. Increased consolidation is boosting margins while stronger capital allocation discipline is ensuring that the industry doesn’t expand capacity too fast. Meanwhile low crude prices and a strong U.S. economy keep the supra-normal earnings going. Analysts have an average price target of $62.54, giving Delta more than 22% upside.

Disclosure: none