(DAL) Airlines Offering Solid Returns

Despite the fact that air carriers are losing money due to persistent market turmoil and surging fuel prices, we believe airline stocks are offering attractive returns and are the best bets at this point in time.

The airline industry is consolidating in order to regain lost profits and improve operational efficiency. Further, the carriers are cutting capacities and taking several steps to lower their overall costs including fuel and non-fuel.

The wild card is fuel prices, largely a function of geostrategic forces, which are outside of the control of the airlines. We expect crude oil and jet fuel prices to remain largely stable this year, but forecasting this key variable with any level of accuracy has always been extremely challenging.

While air carriers are contemplating a more effective and enduring way to counter rising costs, passing them through to customers in the form of fare hikes seems an easy way out. Major U.S. carriers raised ticket prices on round trips by $20 on long-haul routes, the first fare hike since mid-October last year. The successful increase in ticket prices stems from an additional surcharge of $6 per round trip on flights between the U.S. and Europe implemented early this year. Last year, airlines successfully imposed nine broad fare increases, thanks to the rise in travel demand.

If demand remains strong and fuel prices continue to rise, then carriers would be able to earn more this year through fare hikes even though the Euro-zone sovereign debt crisis will restrict overall economic growth. Additionally, hedging strategies provide a cushion to the rising fuel prices and are being used extensively by the carriers.

Air carriers are further focusing on fleet rightsizing. Though initially expensive, it seems the correct strategy to lower non-fuel costs. Air carriers are replacing their older fleet with new fuel-efficient aircraft, to optimize cost efficiency.

Currently, the stocks seem to be undervalued at their current levels and represent a buying opportunity. Delta Air Lines inc. (DAL), United Continental Holdings Inc. (UAL) and Southwest Airlines Co. (LUV) have the potential upside of roughly 30% from their current levels. US Airways Group, Inc. (LCC) has the potential upside of about 50% while JetBlue Airways Corporation (JBLU) has about 20%.

Further, Delta and United Continental, having our target prices of a respective $9.25 and $19.00, are trading at huge discounts to the peer group and the S&P 500 benchmark, based on 2012 earnings estimates. Southwest having our target price of $9.25 is also trading at a substantial discount to the peer group and the S&P 500 benchmark, while JetBlue having a target price of $5.75 is trading on par with the peer group and at a discount to the S&P 500 benchmark.

Moreover, these stocks look cheap considering their price-to-sales (P/S) ratio, which is lower than one (infact, below 0.50 times) and well below the S&P 500 benchmark (which is currently 2.22 times).

Going forward, these carriers will add new features to their services as well as introduce products, which will enhance their value and profitability. Carriers are going wireless with the in-flight entertainment systems such as American Airlines’ Gogo “Vision” wireless video-on-demand and Delta Air Lines’ “Delta Connect”. Other carriers will soon launch their in-flight entertainment systems. These facilities would add to their value and drive stock prices upward.

Besides, Delta Air Lines and United Continental are installing winglets, WiFi and flatbed seats apart from expanding Economy Comfort or Economy Plus seats to their fleet. Southwest Airlines continues to benefit from EarlyBird check-in, unaccompanied minor travel and pet fees as well as the Rapid Rewards program. JetBlue is poised to benefit from continued success in the Getaway Vacations Division as well as the Even More Space product.

Moreover, the carriers continue to expand their footprints both on the domestic and international fronts. We believe these efforts and developments will infuse profits in the industry, making the stock attractive at current levels.

While waiting for the fourth quarter and fiscal 2011 earnings to release, the Zacks Consensus Estimates for Delta and United Continental are $2.22 and $5.18 for fiscal 2012, representing a substantial increase of 68.79% and 52.30% year over year. Southwest and JetBlue earnings are expected to almost double this year. The Zacks Consensus Estimates for Southwest and JetBlue is 80 cents and 49 cents for fiscal 2012, representing whopping increases of 95.13% and 102.06%, respectively, year over year.

We believe the U.S. air carriers will emerge as successful candidates this year with balanced debt and reduced costs amid tough conditions stemming from the government’s inability to find any resolution to the Euro-zone sovereign debt crisis.

We currently have our long-term Neutral recommendations on Delta, United Continental, Southwest and JetBlue. For the short term (1–3 months), the stocks retain the Zacks # 3 (Hold) Rank.

DELTA AIR LINES (DAL): Free Stock Analysis Report

JETBLUE AIRWAYS (JBLU): Free Stock Analysis Report

US AIRWAYS GRP (LCC): Free Stock Analysis Report

SOUTHWEST AIR (LUV): Free Stock Analysis Report

UNITED CONT HLD (UAL): Free Stock Analysis Report

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