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Barron’s ran an article last week stating that airline stocks still have 50% upside over the next year.
Though it could have been a coincidence, it certainly appears that some of the key players in the airlines space got a “Barron’s bump” from the article’s extremely bullish stance. The piece noted that the biggest players are best, and offer the most upside. This includes the big four: American Airlines (NYSE: AAL), Delta Air Lines (NYSE: DAL), United Continental (NYSE: UAL) and Southwest Airlines (NYSE: LUV).
Shares of American Airlines and United did the best this past week, with both up over 5%.
It’s no secret that fuel costs are the largest expense for airline operators. About a third of an airline’s entire cost is usually fuel. But over the last six months, the airline index has fallen almost in lockstep with the price of crude oil.
And while it’s true that deregulation and a string of bankruptcies and mergers is finally leading to profits for the industry, the worry is that the industry is getting too excited and expanding too fast. The idea is that there are just too many flights available today, which is leading to oversupply. This could force prices lower.
But I still believe that airlines have at least learned a little bit over the last few decades about capacity. On the positive side, Southwest has said it would slow capacity and route growth to prevent putting downward pressure on prices.
Things still aren’t all that rosy, however – at least not for the biggest airline operators. Low-fare competition is heating up in the major markets. At the same time, low oil prices are hurting business travel among major oil companies, and flights to major oil markets are in decline.
With that in mind, you really have to do the legwork to find airline stocks worth owning.
Take American Airlines for example. The story of its glory is well told. And yet the stock is down 20% year-to-date – more than any other player. The market just doesn’t care that American Airlines has no fuel hedges and enjoys the full benefits of lower oil prices. Not to mention that it’s the cheapest from a valuation perspective, trading at a price-earnings ratio below 10.
But there are still overlooked airlines that could offer upside. I talked about both Southwest and JetBlue (NASDAQ: JBLU) as interesting growth opportunities earlier this month, but they are fairly well-known.
Let’s take a look at two underrated airline stocks:
Alaska Air Group (NYSE: ALK)
Alaska Air has a monopoly on the state of Alaska, which doesn’t sound all that exciting. But this advantage has led to a solid track record of industry-leading returns on invested capital. Alaska Air is one of the leaders in terms of shareholder returns, and it uses its strong cash flow generation to buy back shares and pay dividends.
Its balance sheet is also one of the best in the industry. It carries a lot less debt than other airlines, and can thus funnel more cash to shareholders without the burden of debt payments.
There have been some interim headwinds related to Delta entering one of its core markets, Seattle. However, the expected negative impact of this isn’t as bad as expected and should help drive renewed interest in Alaska Air.
SkyWest (NASDAQ: SKYW)
SkyWest is one of the largest regional airlines. It serves much of North America through its namesake airline along with subsidiaries Atlantic Southeast Airlines and ExpressJet. It had some hiccups with the ExpressJet acquisition a few years back, so it’s still playing catch up.
SkyWest’s new growth plan includes focusing on larger planes and getting more entrenched with serving the larger and more stable airlines. The other beauty to its business is the long-term fixed-fee contracts it has with airline companies.
It just so happens that the two stocks I picked above also happen to be the best dividend payers in the industry. Alaska offers a 1.2% dividend yield and SkyWest offer a 1% yield.
It’s worth noting that both of these overlooked airlines are the only airline stocks that are up over the last year. But have no fear, there could be more upside in store.
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