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After a Soaring Bull Market, What's Up for Airline Stocks?

Zacks Equity Research

Anniversaries call for celebrations but at the same time every passing year offers scope for deliberations, particularly about the measures that should be taken to improve the future performance.

Mar 9, 2017 is the 8th birthday of the highly acclaimed U.S. bull market. The terrible financial crisis that had gripped the nation eight years ago resulted in a stock market bloodbath.  The U.S. stock market slipped to its lowest level on Mar 9, 2009. Major indices like the S&P 500 and the Dow Jones Industrial Average were all struggling big time to combat the blow dealt by the financial crisis.

However, the market has come a long way since then. The Dow has soared 200% from the 6,500 level. The S&P 500 Index ended the Mar 8, 2017 trading session at 2,363, substantially above  676.5 that it had slipped to at the end of business on Mar 9, 2009.

Airlines’ Gloomy History

When the entire economy was in the doldrums during the recession, these stocks were not spared either.

It was not too long ago that stocks in the airline space were going through an extreme financial crisis. High fuel costs added to the woes of the carriers. Many of these companies, including big names like Delta Air Lines DAL, even filed for bankruptcy protection. Nonetheless, Delta eventually managed to avert bankruptcy through its merger with Northwest Airlines.

Another sector participant, United Airlines had also filed for bankruptcy in 2002. The company in its current form – United Continental Holdings UAL – was formed in 2010 following the merger of United Airlines and Continental Airlines. United Continental holds a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

American Airlines had filed for bankruptcy in 2011. The subsequent merger of AMR (American Airlines' parent group) and US Airways in 2013 resulted in the formation of the now American Airlines Group AAL.

Oil Price Fall: A Huge Boon

The outbreak of the deadly Ebola virus in 2014 dealt a major blow to airlines stocks.  However, Ebola-induced fears diminished gradually, and this coincided with the free fall in oil prices. Since costs associated with fuel are one of the biggest expenses for airlines, low crude prices led to massive savings for carriers, boosting their financial health. Naturally, this caused a massive rebound in airline stock prices, helping carriers like American Airlines and Delta Air Lines, which had filed for bankruptcy protection, rake in huge profits.

The financial prosperity in the airline space even prompted carriers to pay out dividends alongside engaging in activities like share buybacks and profit sharing. In Feb 2017, Delta paid more than $1 billion to its employees as part of its profit-sharing plan for 2016. This is the seventh consecutive year where the carrier has shared profits with its employees.

Low-cost carrier Southwest Airlines LUV paid $586 million to its employees as part of its profit-sharing plan for 2016. American Airlines, which was earlier opposed to profit sharing, changed its stance and embraced the scheme last year.

Airline Surge

The fact that airlines have gained substantially from Mar 2009 can be made out from the fact that the Zacks categorized Transportation-Airline industry has gained a whopping 376.2% over the last eight years. This is substantially higher than the S&P 500 Index’s gain of over 210% in the period.

In fact, S&P 500 members like Delta, Southwest Airlines, Alaska Air Group ALK, United Continental Holdings and American Airlines have all made spectacular gains since the gloomy Mar 2009 days.

 

Is There Scope for Further Growth?

We believe that the answer to the above question is a resounding “Yes.” Let’s find out why.

Cheap Valuation

Going by the EV-to-EBITDA (enterprise value to earnings before interest, tax, depreciation, and amortization) ratio, which is often used to value airline stocks, given their significant debt levels and high depreciation and amortization expenses,the industry doesn’t look expensive at this point.
 
The industry currently has a trailing 12-month EV/EBITDA ratio of 5.9, which is favorable than what the industry saw over the last eight years. The ratio is nearer the low end of 2.3 and far off the high end of 16.5 during the period.

Additionally, the reading compares favorably with the market at large, as the current EV/EBITDA for the S&P 500 is 11 and the median level is 8.4. The industry’s favorable positioning compared with the overall market certainly signals more upside. 

Other Bullish factors

Unit revenue woes, which had plagued the industry not so long ago, seem to be mitigating. This is evidenced by the fact that many carriers are looking to return to unit revenue growth in 2017. Moreover, improvement in oil prices should enable carriers to raise ticket prices, thereby boosting revenues.

The prospects of the airline stocks were further boosted with Warren Buffett's recent interest in the space after having shunned the sector for quite a long time. Buffet’s Berkshire Hathaway increased stakes in airline heavyweights like American Airlines, Delta and United Continental Holdings in the fourth quarter. Moreover, Buffett has invested heavily in low-cost carrier, Southwest Airlines.

The bullish Zacks Industry rank of 58 carried by the 25-member Zacks categorized Transportation-Airline industry also highlights the fact that airline stocks are back in favor. The favorable rank places the industry in the top 22% of the 250+ groups enlisted.

Bottom line

The sector’s cheap valuation, Buffet’s renewed interest in the airline space, improving unit revenues are some of tailwinds that indicate the good prospects of airline stocks. Moreover, President Trump promised to modernize the obsolete U.S. air traffic control system . Airline companies are also hopeful that the Trump administration will create a low-tax regime with fewer regulations. In the event of materialization of these promises, airline stocks could soar higher.

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Southwest Airlines Company (LUV): Free Stock Analysis Report
 
Delta Air Lines, Inc. (DAL): Free Stock Analysis Report
 
Alaska Air Group, Inc. (ALK): Free Stock Analysis Report
 
United Continental Holdings, Inc. (UAL): Free Stock Analysis Report
 
American Airlines Group, Inc. (AAL): Free Stock Analysis Report
 
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