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Once a sucker’s bet, these airline stocks may be ripe for investment.
I never used to like airline stocks. Airlines made for a terrible business. The companies were loaded with debt, cash flow was irregular, fuel prices were volatile, competition was fierce, service was terrible, and the entire sector could be wiped out with a terrorist attack.
So many airlines have declared bankruptcy at one time or another that I’ve lost count. There are trash bins piled high with the worthless stock of dead airlines. I vowed never to invest in airline stocks, with one possible exception that I never pulled the trigger on: Southwest Airlines (NYSE:LUV), because it managed to mitigate almost all of these issues.
Still, if you bought Southwest in 1998, you had zero return through the end of 2012.
Now it’s all changed. The last trio of mergers have created an oligopoly, and we always like investing in sectors with limited competition. The airlines figured out that it wasn’t just enough to cut expenses – which began with removing the lettuce leaf you got on your complimentary coach class meal and has ended with food only being available for purchase – but to nail customers by maximizing revenue any way possible.
The most insidious method has been to sell frequent flyer miles. The biggest sucker’s bet since betting snake eyes on the craps table is to pay way more for extra frequently flyer miles at the check-in kiosk than they are worth.
Then, in a move worthy of post-WWI German hyperinflation, the airlines have devalued frequent flyer miles to a fraction of their previous value.
This, however, means good times for airline stock investors. Stock returns have been insanely good. Over the past two years, American Airlines Group (NYSE:AAL) has quadruped, as has Delta Air Lines (NYSE:DAL). United Continental Holdings (NYSE:UAL) is up about 140%, JetBlue (NASDAQ:JBLU) has doubled, and Southwest has tripled.
Don’t I feel foolish?
What’s more, the airlines are in pretty good financial shape as well. Southwest has always had a good balance sheet. It now has $3.1 billion in cash and only $2.1 billion in debt, with $350 million to $1 billion of FCF annually.
American isn’t in fantastic shape, but it’s doing okay. $10.2 billion in cash is offset by $15.3 billion in debt. FCF, however, is negative FY13 had $2.5 billion in negative free cash flow, although that trend is improving.
United’s FCF situation isn’t much better. It was $700 million in the red in FY13, on top of $1 billion the year before. $5.8 billion in cash is offset by $11 billion in debt.
Delta is in decent shape, with $4.2 billion in cash, and $9.1 billion in debt. It is generating positive FCF, to the tune of $2 billion in FY13, $500 million in FY12, and $1.6 billion in FY11.
JetBlue squeezes out a little FCF each year, about $140 million pretty consistently. $627 million in cash is offset by $2.1 billion in debt.
Hawaiian Holdings (NYSE:HA) is holding its own, with small degrees of negative FCF ($100 million). $442 million in cash is offset by $744 million in debt.
Virgin America is planning an IPO. I’d like to see their financials because I generally like their product.
So are airline stocks truly worth investing in? I think so, although a lot of positive sentiment is baked into many of the stocks. I still like Southwest as being the best long-term investment, especially as it moves into international travel for the first time. It’s also the only company that has more cash than debt. The stock has roared back to life sine 2012, however, and the stock has gone straight up. I would wait for a pullback before entering.
Otherwise, I think you go with Delta for its positive FCF. If you want to speculate, the FCF situation at American is turning around, so the possibility for the best gains is probably there.
Lawrence Meyers does not stock in any company mentioned.
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