What to do?
Airline investors have thus seen each of the three network carriers (excluding American) report disappointing cost or revenue performance in the past week. The Delta and US Airways updates are particularly troubling because airline management teams had appeared very confident about demand trends previously. Now investors have to be concerned that tax increases and cuts to government spending will undermine the recent unit revenue growth trend.
However, some airlines are more “at-risk” than others. I continue to expect United Continental and US Airways Group, Inc. (NYSE:LCC) to underperform the industry. United stock is expensive compared to peers, trading at 18 times trailing earnings. On the positive side, analysts currently expect United’s EPS to more than double in 2013. However, the company has projected 5.5%-6.5% growth in non-fuel unit costs for the year, meaning that United will need healthy unit revenue growth to meet those analyst targets. If the airline revenue climate continues to weaken, United could be in for a rough year.
US Airways also seems like a risky stock to own for two major reasons. First, the company has posted unit revenue growth figures at or near the bottom of the airline industry throughout the first quarter. Second, US Airways Group, Inc. (NYSE:LCC) is about to merge with American Airlines. The recent history of airline mergers strongly suggests that earnings performance could suffer during the merger integration process, which could lead to turbulence for shareholders.
By contrast, Delta seems like the safest investment among the “network” airlines. While it missed its revenue guidance last month, costs were lower than expected, which allowed Delta to maintain its profit estimate. Moreover, the company trades at less than eight times trailing EPS, so investors do not need heroic earnings growth to justify the current price. In fact, Delta’s recent cost-cutting campaign and other initiatives should allow the company to post solid earnings growth in 2013 even if unit revenue gains are minimal. Southwest Airlines Co. (NYSE:LUV) and JetBlue Airways Corporation (NASDAQ:JBLU) could also outperform going forward. A soft revenue environment may benefit the low-cost carriers as they can target corporate customers who would normally fly business class on the network carriers but need to cut travel costs. Southwest and JetBlue are also better positioned than the network carriers because they rely more on leisure travel, which tends to be less affected by economic weakness than business travel.
Conclusion
Airlines have been flying high for the past few months, but expectations eventually began to outpace reality. After this week’s correction, long-term investors who want some exposure to the airline sector can buy in at a better price. Among the five biggest carriers in the U.S., Delta is probably the best investment due to its strong profitability and ongoing cost-cutting campaign. United and US Airways Group, Inc. (NYSE:LCC) face more challenging outlooks, due to the former’s significant cost pressures and the latter’s upcoming merger. This makes them unattractive investments at this point.
The article Airline Stocks: Is It the End of the Party? originally appeared on Fool.com and is written by Adam Levine-Weinberg.
Adam Levine-Weinberg is short shares of United Continental Holdings (NYSE:UAL) and is long Sep 2013 $33 Puts on United Continental Holdings. The Motley Fool recommends Southwest Airlines.
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