The beleaguered airline industry, grounded in the hangar and stalled on the runway for four years, appears ready to take off again.
Investors in airline stocks may enjoy the flight.
It's true that improvement in the economy hasn't yet produced long-awaited gains in business and vacation travel. Nonetheless, carriers are returning to profitability because they've accepted that desperate times call for desperate measures.
The industry is broke and can't even afford to order new airplanes until at least a year from now. Lack of new plane orders means the period of overexpansion and overcapacity has come to a halt. All-out competition for market share, responsible for the dismal financial condition of the carriers, appears to be on the way out. Routes and number of flights are now carefully monitored as to their profitability.
Airlines are finally getting their costs under control. Delta Air Lines, for example, recently announced a dramatic $2 billion in cuts in operating costs by eliminating up to 15,000 jobs over several years, which experts are hailing as a message to the entire industry. Labor has also become more understanding of the critical need to get expenses in line.
As a result, the second quarter of 1994 should mark a truly positive turn in airline earnings and probably the best results since 1989. This upward trend is expected to continue for several years. For investors in this highly cyclical business, the time to buy such underperforming stocks is before they're making money, not after it's become accepted reality.
"It's been a pretty sick industry, basically smoking cigarettes, eating greasy foods and acting like a couch potato, but now it's going to get fit," said Rose Ann Tortora, analyst with Donaldson Lufkin & Jenrette. "Even if Delta accomplishes only two-thirds to three-fourths of its cost-cutting plans, it is crucial in setting the debate throughout the entire industry."
The fact that the airline stocks are at the low end of their trading range makes them particularly attractive. But investors in airline stocks must be aware of their potential for volatility. There are always new entrants in the field, which affects ticket pricing, and government policies also often enter into the equation. These are equities that should be bought at low periods in their industry cycle and sold when times are good, not simply held forever.
"People hate airline stocks right now," explained Glenn Engel, analyst with Goldman Sachs. "But since the stocks have already been hammered in price and their upside potential is large, investors can have a free look at them over the next three months."
Economic recovery both in the United States and Japan should provide an added boost, adding to general optimism among industry analysts.
"This is the first time I've been recommending the three largest carriers all at once, and just one year ago I was recommending the sale of all three," remarked Michael Derchin, analyst with NatWest Securities. "Now, at the low end of their trading range, they're worth considering."
Some turbulence remains. "A rebound in oil prices and the very high debt loads of the carriers will serve to slow the rate of industry recovery," warned Samuel Buttrick, analyst with Kidder Peabody. "The earnings power of the carriers has also been severely curtailed during the difficulties of the past several years."
Yet there's still unanimity in the belief that this is a prime opportunity for investors with the calm temperament to play the airline investing game.
Delta Air Lines, AMR Corp. (the parent company of American Airlines), and UAL Corp. (parent of United Airlines) are stock recommendations of all four analysts interviewed for this column.
While the market is skeptical about whether Delta can meet its ambitious goals, the fact that it's 87 percent nonunion will make change easier. American's low stock price overlooks its lucrative computer-reservation system and management services businesses. The complex United financial restructuring, in which employees will wind up with an initial 53 percent of company stock, should be a plus for existing stockholders who receive an impressive package of cash and securities. But the pilots' union has recently talked of renegotiating buyout terms because of the slide in the UAL stock price.
Southwest Airlines, despite a recent flap in which this low-cost carrier was ousted from the Apollo airline-reservations system and limited in others, is favored by the Mr. Buttrick and Mr. Derchin. It will find ways to get around the problem, including using a computer system of its own, they believe. Apart from that issue, Southwest will be facing increased competition as larger carriers cut their prices on certain routes.
Some smaller carriers also offer investment promise. Alaska Air Group, which has seen its traffic rise by 50 percent since it slashed operating costs and cut fares, and Tower Air, which leases 747 long-haul airplanes, are additional Engel stock selections.