Can Low Fuel Costs Keep Airlines Aloft?

• ByDavid Sterman, RealMoney Contributor
• On 10:30 am EST, Wednesday November 26, 2008

With equity markets in free fall, a sharp reduction in energy prices in recent months has been one of few silver linings -- particularly for the airline industry.

About a month ago, I suggested that airlines stand to benefit greatly from the falling price of oil, even as demand for air travel is likely to slump. Since then, oil has continued its slide, down to $50 a barrel. By my math, that one-month drop should translate into an additional $8 billion in fuel savings for the airline industry, on top of the $11 billion in savings when oil went from $110 to $75 a barrel.

Judging by industry share prices, investors may be betting that the cumulative $19 billion in savings will be less than the offsetting reduction in revenue seen by the industry in an economic slowdown. Demand for first class and business class seats fell 8% in September, according to the Air Transport Association. That figure likely worsened in October due to the global market paralysis we've seen, but it's unclear yet if air travel will fall off a cliff, as many industry bears predict.

Fears of price wars are also on investors' minds. Yet the sharp capacity reductions appear to be supporting prices for now. The carriers are expected to take even more planes out of the system in January, and if airfares can hold their own when that happens, investors should take that as a bullish sign.

The key for airlines is to lock in these low oil prices by establishing new hedges. Right now, they appear to be holding off after recent hedges at higher prices led them to leave money on the table. But you have to wonder if they really think oil can fall to $40 or even $30 a barrel. To wait for that, and leave themselves exposed to a possible turnaround in oil prices, looks foolhardy. OPEC's pledges to cut production are not being taken seriously, but for the carriers, it's a threat they shouldn't take lightly.

After poring through recent filings, I have not seen any evidence of hedging, but if you have, please drop me a line.

Southwest Air remains the "safest" play in the group -- the airline making all the right moves in terms of strategy. JetBlue continues to possess considerable assets in terms of brand equity and access slots. Continental is the most likely beneficiary of continued industry consolidation.

Cash Is Still King

A story from six weeks ago listed companies with large cash balances. With stocks sinking further, an update on the names on this list is in order. (Note that SanDisk has been removed from this updated list as I overlooked the company's off-balance-sheet liabilities.)

In the accompanying table, cash balances have been updated to reflect net cash positions subsequent to quarterly results issued in the September quarter. (Please note that these figures are unaudited, and you should read the quarterly filings, especially their footnotes, while researching these companies.) Since last month, most of these stocks have fallen along with the broader market, which shows that pristine balance sheets are getting little credit right now. Conversely, the further drubbing makes the stocks yet more appealing in the context of cash-to-market capitalization ratios.

When it comes to companies such as KBR , McDermott and IAC/Interactive , investors are currently more concerned with the outlook for 2009 sales trends than with balance sheet strength. As the market gets past this brutal stage, that sentiment may shift.

Cash Screen Company Ticker Net Cash ($M) Market Cap. ($M) Cash / Market Cap. KBR KBR 1,530 1,980 77% McDermott Int'l MDR 1,275 2,030 63% IAC/InterActive IACI 1,660 2,110 79% Sun Microsystems JAVA 1,800 2,260 80% Motorola MOT 2,720 9,040 30% Health Net HNT 400 871 46% NVR NVR 801 2,230 36% Dell DELL 7,913 20,350 39% Foster Wheeler FWLT 800 2,880 28% Lam Research LRCX 745 2,390 31% Abraxis Bioscience ABII 653 2,160 30% Broadcom BRCM 2,280 7,720 30% Red Hat RHT 795 1,770 45% Boeing BA 6,800 2,950 231% Source: Yahoo! Finance

Buzz up!