Is There Turbulence Ahead for Airline Stocks?

Is There Turbulence Ahead for Airline Stocks?

In October, the International Air Transport Association lowered its full-year profit estimate for the global airline industry to $11.7 billion -- from the June forecast of $12.7 billion -- as a result of fuel cost increases and weak demand in some emerging markets. But IATA still anticipates a solid end to 2013 and a much stronger 2014, with industry net profit as high as $16.4 billion -- the second best such figure on record, and more than double the profit recorded in 2012. Let's look a three airlines that might be particularly well-positioned to enjoy this rosy outlook.

What's not to LUV about these quarterly results?
Southwest Airlines has achieved a remarkable feat: 40 consecutive years of profitability, which is particularly amazing given the financial ups and downs of some of its peers.

The company built its reputation as a no-frills, low-fare airline, but in recent years has introduced strategic initiatives to make the flight experience more enjoyable for passengers, including a new cabin design called Evolve that features more comfortable seating and additional legroom.

Third-quarter results were remarkable as well, with operating revenue up 5.5% to $4.5 billion. Southwest's net income was a record $241 million, a 148% increase over the same quarter last year. Part of the positive variance was due to the company incurring $145 million in costs in last year's third quarter related to the acquisition of AirTran. Not counting those costs, net income was still up a solid 11.1% in 2013.

Southwest's number of enplaned passengers was down 3.2% compared to the third quarter of 2012, but the average fare increased more than 11%. The result was a healthy 5.1% increase in the important airline metric known as PRASM, or passenger revenue per available seat mile.

In recent years, airlines have used their assets more efficiently, boosting profits even amid relatively slow global economic growth. Southwest's cost management was extremely efficient during the quarter: total operating expenses dropped 2.4%. Management projects that the combination with AirTran will generate $400 million in "pre-tax synergies", aka savings for the year.

Rapidly gaining altitude
JetBlue Airways strategy reminds me of upscale discount retailers such as Target. JetBlue tries to balance low fares with superior service, attracting both cost-conscious travelers and those who want to travel in slightly more style and comfort than a municipal bus system could offer.

In the second quarter, JetBlue reported a drop in operating income and PRASM compared to the same quarter last year. The recently reported third-quarter results showed considerable improvement, in sync with IATA's optimistic forecast for year-end. PRASM rose 5.4% compared to last year's third quarter and revenue for the quarter was a record $1.4 billion, a more than 10% increase over last year. Operating income totaled $152 million, an outstanding 34% increase year over year.

The three largest expense categories -- including fuel and personnel costs -- all increased by smaller percentages than overall revenue. The only significant cost increase year over year was for maintenance materials and repairs, up 28%.

Connecting Hawaii to the world
Hawaiian Holdings is the parent company of Hawaiian Airlines, which offers nonstop service to Hawaii from 11 U.S. gateway cities -- more than any of its competitors. The company also offers service to other countries such as Japan, Australia, and South Korea. It hopes to begin service to China in 2014.

If you're in a hurry to start your Hawaiian vacation, this is the airline for you. For nine straight years, Hawaiian Holdings has led all U.S. air carriers in on-time performance.

For the third quarter, revenue was up 9.1% compared to the same quarter of 2012. PRASM increased just a modest 0.2%, and CASM or cost per available seat mile not including fuel rose 2.1%. A 9% increase in available seat miles drove that revenue boost, since the company is confident enough about the industry outlook to add capacity.

Two major operating expense categories, fuel and wages/benefits, increased more on a percentage basis than revenue, up 9.4% and 20%, respectively. Maintenance materials and repairs were up 17.1%. As a result, operating income declined a bit, less than 1% for the quarter, to $74.4 million.

What we learned
PRASM and CASM may sound silly, but for airline CEOs in an industry with thin margins, these serious metrics spell the difference between record earnings and mediocrity.

The airline I would most like to fly on is Hawaiian, but it's not necessarily the one I would invest in. The company's strategy of expanding its fleet and focusing on building tourism from Asia has yet to produce noteworthy earnings gains.

Both JetBlue and Southwest merit consideration in light of IATA's encouraging forecast. In the wake of the US Airways/AMR merger, they have the potential to snap up slots at key airports, providing further momentum for their future growth.

For the quarter, JetBlue reported a 4% increase in the number of revenue passengers served and a 6.5% increase in average fare -- the ideal combination of more customers willing to pay more.

But Southwest's financial condition is very strong. At quarter's end, the company had about $3.6 billion in cash and short-term investments, and an available credit line of $1 billion. This company's financial management is superior, particularly in a capital-intensive industry like air travel.

Thanks to its consistent performance, Iong-term investors might want to look first at Southwest for a solid potential airline investment.

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