Airline stocks have long been shunned by value investors given the high degree of cyclicality involved. However, it appears to be changing if one takes a looks at the recent performance of air carriers such as SkyWest, Inc. (NASDAQ:SKYW), Southwest Airlines Co. (NYSE:LUV), and PHI Inc. (NASDAQ:PHII).
Airline companies are not only flying fuller planes but they also seem to have understood the importance of managing debt levels – two of the biggest factors why the companies kept losing money though the previous decade or so.
According to the data released by the U.S. Bureau of Transportation Statistics, airlines improved occupancy levels of their planes to a record 83 percent in 2012, up from 72 percent in 2011. This discipline was well complemented by strength in domestic fares during the year.
While the stocks have seen a smart rally so far, it would be early to conclude that the gains from these initiatives have been completely factored in the prices. Here is why there may be more upside in these stocks:
Southwest Airlines Co. (NYSE:LUV) is essentially a low cost passenger airline player which offered services in 97 destinations in 41 states at the end of 2012. Being a low cost player, the company focuses on point-to-point service instead of “hub and spoke” model adopted by major airlines. One big advantage of this model is high asset utilization as these secondary or downtown airports are typically less congested than the hub airports used by larger players.
This simple shift appears to have contributed to a 9 percent growth in revenues in 2012 while profits grew to $421 million from $178 million in 2011. This performance is likely to continued as reflected in its future price earnings ratio of just 11. Low debt equity ratio of nearly 0.45 is another factor expected to help in achieving higher profits on additional revenues. Even though it has advanced by 24 percent during the past quarter, the stock continues to trade at a discount to its price targets which are around $15.
Regional airlines are hit
Utah-based regional carrier SkyWest, Inc. (NASDAQ:SKYW) has seen its stock push higher by 29 percent over the previous quarter but still trades at 11 times its forward earnings. On a trailing 12-month basis, PE multiple works out at 16.4 – not expensive by any standard.
What’s more, its market price is still 40 percent below the book value. The fact that the regional airline business is better suited to exercise the above mentioned financial discipline is highlighted in the recent quarters.
In the last three months, the company swung to a profit of $13.9 million even though top line did not grew. Regional airlines typically operate smaller aircrafts on lower-volume routes than major carriers. However, instead of competing with major airlines, regional players usually enter into revenue-sharing agreements with one or more major players which results in regional player’s smaller, lower-cost aircrafts being used by a bigger player.
As of December 31 2012, 557 of the company’s 559 small regional aircraft operated under fixed-fee agreements with other players including Delta and United. This way, regional airlines are better shielded from unpredictable fuel costs. As bigger players are witnessing a windfall of sorts, some of these benefits are tricking to regional players too.
Air services too not behind
The factors mentioned above are not only true for airline companies but also for mission critical air service provider PHI Inc. (NASDAQ:PHII), which operates a fleet of helicopters in the Gulf of Mexico. The company largely caters to the oil and gas industry in addition to offering air medical transportation for hospitals and emergency service agencies.
Over the last 12 months, the company has seen a significant traction in demand of its services. As a result, revenues grew 19.8 percent to $646.7 million. High operating costs mean margins are thin in this business but the company still managed to grow its profits to $18 million during the year from $4.8 million in 2011.
After sustaining significant adverse impact of the Macondo oil spill on its business in recent years, the company appears to be suitably placed to benefit from renewed activity in deep water drilling in the region. Although PHI is not tracked by analysts, it would not be surprising to see the growth continuing in 2013 as well.
Despite positive outlook for these companies, investors would do well to keep an eye on oil prices which is the key input cost for all the three companies.