Here's One Sector You'd Never Want to Take to Vegas

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Here's a news flash -- fuel prices for the third quarter were down across the board for the airline industry. Not only is this odd given that fuel prices traditionally rise throughout the third quarter, but it would normally spell good news for passengers because it offers even less incentive for airlines to raise their prices. But don't tell that to Delta Air Lines (NYS: DAL) and the other major carriers that initiated yet another price increase this week, marking the 19th such time this year they've attempted to raise travel fares.

Well, folks, there's a reason your broker puts that little note in fine print at the bottom of those legal disclaimer that reads "past performance in no guarantee of future results" -- and this quarter, many airlines learned this the hard way. With prices traditionally rising at this time of year, airlines hedged their fuel costs heavily only to find out too late that fuel prices were falling, forcing many to take hefty writedowns during the quarter.

Alaska Airlines (NYS: ALK) , for example, reported a 12% rise in revenue and a 7.1% jump in traffic but was forced to take a $52 million loss on its fuel-hedging activities, knocking profits down by 37% year over year.

Wall Street darling Southwest Airlines (NYS: LUV) also fell under the fuel-hedging guillotine in the third quarter -- even more so than Alaska. Despite a 35% revenue jump over the year-ago period, which was aided by the addition of AirTran in May, Southwest posted a $140 million quarterly loss. This marks the first loss in two years for Southwest, and its last loss was also due to fuel-hedging practices.

Unlike most airlines that have a fuel-hedging portfolio that consists of a mixture of heating oil, jet fuel, and West Texas Intermediate (WTI) crude oil, Southwest is heavily levered toward WTI. When WTI crude took a dive during the quarter, it spelled another monstrous paper loss for the airline.

Other airlines that are set to report later this week will probably fare better than Southwest because their fuel hedges are generally more balanced, including United Continental (NYS: UAL) and Delta -- though both companies will still probably suffer paper losses from hedging, I suspect . US Airways (NYS: LCC) is the only major carrier not to hedge its fuel costs, so I'd expect solid results from the company when it reports later next week.

What this quarter and many over the past few years has taught me is that the airlines are terrible predictors of the future price of oil, or any fuel for that matter. Recently, more often than not, solid quarterly results have been smirched by paper losses stemming from fuel-costs hedging activity. My advice to the airline industry would be to get a Magic-8 Ball and hope for the best. As for investors, if you're heading to Vegas for a week of fun in the sun and gambling, you should be OK as long as none of your friends works for the airline industry as a professional fuel-cost broker.

Despite lower jet-fuel prices last quarter, prices were still up sharply from a year ago. Many experts believe that another oil spike may be right around the corner. Be prepared with this well-positioned energy stock. In this free report, our Foolish analysts have discovered The One Energy Stock You'll Ever Need. Access to the report is free!

Do you place any credence in the losses or gains achieved by fuel-cost hedging in the airline sector, or is it just the same smoke and mirrors we see in the banking sector? Sound off in the comments section below and share your reasoning. 

At the time this article was published Fool contributorSean Williamshas no material interest in any companies mentioned in this article, but derives great pleasure from pointing out the imperfections of the airline industry. You can follow him on CAPS under the screen nameTMFUltraLongand on Twitter, where he goes by the handle@TMFUltraLong.Motley Fool newsletter serviceshave recommended buying shares of Southwest Airlines. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has adisclosure policy.

Copyright © 1995 - 2011 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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