Cowen Says Overweight the Airlines: U.S. Airways-AMR Deal Likely Gets Done

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Airline stocks have been a frustrating mistress over the past 25 years. Investors became accustomed to airlines and their frequent trips to bankruptcy, and then often to the airline graveyard, where Eastern, TWA, Pan AM, Braniff and many others currently reside. However a funny thing has happened. The airlines actually have learned that they have a somewhat captive audience, and that audience now has to pay myriad fees when they fly. This has increased revenue, and the analysts at Cowen and Co. think that 2013 will be a record year for profits. The Cowen team points to the airline industry’s outperformance of 1985 to 1992, when the sector had a similar theme of technology improvements and market consolidation. They think that 2013 to 2018 should see similar stock performance, as planes get upgraded and tech improves along with market consolidation.

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Cowen also feels that there is a 60% chance that the huge current pending deal between U.S Airways Group Inc. (LCC) and bankrupt AMR Corp. (AAMRQ) does indeed get done. The Justice Department is fighting the deal primarily because of the huge gate advantage the combined company would have at Washington's Reagan International Airport. U.S. Airways already has made gate concessions at London's Heathrow, and there was reasonably quick European approval for the deal. Most analysts believe that a similar gate deal can happen at Reagan and other major airports where the Justice Department has concerns. Another recent report shows the of support Hunter Keay, a Wolfe Research analyst in New York, who has set the odds at 75% that a U.S. Airways-American merger occurs by early 2014. He rates U.S. Airways as Outperform, the equivalent of Buy.

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In an amazing show of unity, everybody from the pilots to flight attendants to mechanics unions have strongly backed the corporate leadership in this combination. For the Justice Department lawyers to argue that the merged company will be too big and stifle competition is a joke after allowing the huge mergers that have taken place in the past five years. Cowen has said in past research reports that if the U.S. Airways-AMR deal gets done, the stock could double from current levels. The Thomson/First Call price target for the stock is at $23.50. While shares currently trade at just over six times earnings, a merger could lead to substantial multiple expansion.

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The absolute worst case scenario is that the deal does not get done. With that still a possibility, investors may want to consider buying half positions at current levels and wait for the outcome. Should they win or settle, of course the stock will immediately trade higher. If they lose, the stock probably falls back to the $13 to $15 level. There investors could buy the rest of their position and feel pretty good about where they own it. Even left standing on its own, U.S. Airways is a solid stock to buy, bolstered by an extremely positive outlook for profits, strong travel demand and falling jet fuel prices.

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In their report, the Cowen team was also very bullish on the prospects for United Continental Holdings Inc. (UAL). The company will soon be hosting its first investors day in years, where they will update the contingent of Wall Street analysts covering the stock on current and forward-looking conditions. Cowen believes the company will make a number of shareholder friendly comments. It is paying down debt, returning capital to shareholders, investing in the product and turning out a better product for its travel customers. This is good news, as the merger has been plagued by technical glitches more than once. The current consensus price target for the stock is $36.

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Investors rarely get a shot at a binary event trade where, if it does not go their way, they still have a chance to make money and own a good stock. In the case of the U.S. Airways-AMR deal, that is exactly the case. Between solid sector fundamentals and a growing business of its own, owning the U.S. Airways stock is on the surface a win-win situation.

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