Apple Inc. (NASDAQ:AAPL), Delta Air Lines, Inc. (NYSE:DAL) and a couple other airliners are some of David Tepper’s biggest positions. How have they helped him to become one of the most successful hedge funds in today’s marketplace?
Billionaire David Tepper’s hedge fund, Appaloosa Management, reported in a letter to investors that it returned 16.8% in the first half of 2013, outperforming the S&P 500. This continues Tepper’s record of strong returns for his investors, with net annualized returns of 28% over the last 20 years. A major contributor to Appaloosa’s outperformance so far in 2013 has been one of investors’ most hated industries: legacy airlines. We track quarterly 13F filings from hundreds of hedge funds, including Appaloosa, as part of our work researching investment strategies; we have found, for example, that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year (learn more about our small cap strategy) and our own portfolio based on these techniques has outperformed the S&P 500 by 33 percentage points in the last 11 months.
According to our database, three of Tepper’s ten largest holdings in his most recent 13F were legacy airlines. United Continental Holdings Inc (NYSE:UAL), his second largest 13F position, is up 44% year to date; US Airways Group Inc (NYSE:LCC) has risen 37%; and Delta Air Lines, Inc. (NYSE:DAL) has gained 78%. For purposes of comparison, the rest of Appaloosa’s top ten picks from its most recent 13F, which include Apple Inc. (NASDAQ:AAPL) and Citigroup Inc (NYSE:C), have returned 22% on average- still better than the S&P 500, but clearly the fund owes a good deal of its performance to the airlines. Check out the full list of Tepper’s stock picks.
Even with legacy airlines appreciating considerably so far this year, they actually still generally carry low multiples in terms of their forward earnings estimates. US Airways Group Inc (NYSE:LCC) is valued at only 6 times consensus earnings for 2014. The company will take on some integration risk, of course, but that would have to be balanced against the fact that it has the highest upside from consolidation as it gains market share on many of the routes it currently shares with American. Its operating income increased by 19% last quarter compared to the second quarter of 2012, almost entirely due it success controlling costs. Billionaire George Soros’s hedge fund reported a position of 7.8 million shares at the beginning of April (find Soros’s favorite stocks).
United Continental Holdings Inc (NYSE:UAL) was unprofitable in Q4 2012 and in the first quarter of this year, but losses had been smaller than expected before the company turned a profit between April and June. After adding back special charges it has seen little change in operating income compared to a year ago, but the sell-side expects the company to improve enough next year that earnings per share will be $4.72. That is essentially equal to four times what United Continental Holdings Inc (NYSE:UAL) earned last quarter, and results in a forward P/E of 7. Ken Heebner’s Capital Growth Management is another major shareholder in United Continental (research more stocks Heebner likes).
Delta Air Lines, Inc. (NYSE:DAL) trades at 7 times forward earnings estimates- and, in fact, at only 10 times its trailing earnings making it an arguable value stock in those terms. Its financials also show an improvement in terms of costs, aircraft fuel in particular. We wouldn’t expect earnings increases generated primarily by higher margins to be sustainable over the long term, but as we’ve seen the airlines are delivering enough earnings at their current run rate that they really only need to maintain present performance. Billionaire Stanley Druckenmiller had more than doubled the size of his own position in Delta Air Lines, Inc. (NYSE:DAL) during the first quarter of the year (see more stocks Druckenmiller was buying).
As a result even with these stocks’ strong performance year to date and with the substantial risk which comes with investing in airlines- all three mentioned here have been bankrupt at some point- they are still worth considering for a value portfolio. It might be a bit too risky to concentrate one’s portfolio entirely on the industry, but the forward earnings multiples are certainly low in absolute terms. It will also be interesting to see if Tepper took profits on any of these positions when Appaloosa releases its next 13F filing later this month.
Disclosure: I own no shares of any stocks mentioned in this article.
