The airlines are another group that can’t seem to get any respect from investors. While the airlines’ past behavior provides some justification for fear and loathing, they appear to have learned their lessons. As a result, investors who are willing to let by-gones be bygones will find that airline stocks could give them a good ride in the months to come.
Over the last few decades, many of the airlines went through boom and bust cycles. When times were good, they expanded rapidly, buying new planes, adding routes, adding debt and letting operating costs creep up. Then there would be an economic downturn, and the companies would be unable to cut back fast enough, and so they would be forced into Chapter 11 – or even Chapter 22 or 33 (the informal name for a company’s second or third bankruptcy). Having been burned a few times by this behavior, investors became very reluctant to buy airline stocks, even when the financial results looked pretty good.
Now, however, the airlines appear to have finally mended their ways. After US Air, Delta and United emerged out of Chapter 11 bankruptcy in the mid-2000’s, the carriers began to show some discipline. They did not expand rapidly when things were good in 2005-07, and they cut back rapidly at the first hint of the 2008 downturn. They have continued to show good discipline ever since. The result is that planes are full, and the companies can raise ticket prices and charge extra fees for many services that used to be free.
But many investors are still unwilling to buy airline stocks because they expect the carriers to revert to their past behavior pattern. As a result, the stocks look cheap. Earnings and cash flows are strong and growing. Moreover, the coming merger of US Air and American will further reduce both capacity and competition, which should boost profitability across the industry. There is always a risk that some airlines might go back to their bad ways, but we don’t expect that, and we think the gain potential outweighs that risk. Moreover, if cash flows remain strong, we might even begin to see some meaningful dividend paying stocks.
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