"If there's one sector that stands to benefit handsomely from a further slide in oil or, at least, a moderation in crude's rally: the airlines," explains energy sector expert Elliott Gue.
In The Energy Strategist, he says, "Airlines may make a terrible long-term investment but can be an outstanding short-term trade." Here he looks at Delta Air Lines (NYSE: DAL) and, for the even more speculatively-inclined, US Airways (NYSE: LCC).
"Some investors will rightfully cringe from any mention of this sector; after all, the airlines have consistently lost money throughout their post-deregulation history.
"Most of the majors have declared bankruptcy on multiple occasions since that time. However, we've traded the airlines on a few occasions; we took some triple-digit percentage gains in the airlines back in 2005.
"The airlines' leverage to oil prices is well known. Expectations are so low, in fact, that several major air carriers actually managed to beat consensus expectations in the second quarter.
"And although sentiment is already at rock-bottom, there's a real basis for cautious optimism. First, if I'm right about oil, fuel costs won't rise appreciably in the third quarter. This huge headwind is dissipating.
"Meanwhile, the major carriers are finally taking real steps to address pathetic profitability. The most important step is capacity rationalization and restructuring. The air carriers are retiring older planes and permanently ending service for certain routes.
"The US airline industry has too many planes flying over too many routes; there just aren't enough passengers to make this model profitable. Reducing capacity lowers operating costs and brings service in line with passenger volumes.
"And anyone who's flown recently knows the major air carriers are all instituting extra fees and charges, including checked baggage fees and a few extra dollars for that Bloody Mary on your flight home from Las Vegas.
"Airlines are also replacing inefficient, decades-old airplanes with newer, more-fuel-efficient planes, such as the Boeing 787 Dreamliner. Finally, there's scope for further consolidation. US airlines will merge or be taken over, reducing the number of competitors and enhancing the surviving carriers' pricing power.
"My two favorite airlines for a trade are US Airways and Delta Air Lines. Delta reported a $1 billion loss in the second quarter, but that includes a $1.1 billion, noncash accounting charge known as goodwill impairment; if we net that out, Delta actually posted a small profit.
"Quite frankly, that's amazing given the more than 100% jump in fuel costs the carrier has experienced over the past year.
"Delta is aggressively cutting costs and reducing capacity. The company's debt is 2.42 times its equity; for almost any business, that would be considered pathetic except for the airlines.
"Delta has $1 billion in undrawn capacity on its credit lines and $3.3 billion in unrestricted cash; the company isn't going bankrupt any time soon.
"Delta is also in the process of merging with Northwest Airlines. In the company's most recent conference call, Delta raised its projected savings resulting from this merger considerably. I'm adding Delta to our speculative 'gushers' portfolio as a buy below 8. I see the potential for the stock to reach the mid-teens.
"Please be advised that buying airlines is extremely risky. You should only take this trade if you're willing to assume a far-higher-than-average risk and are ready to treat it as a trade, not an investment.
"For the even more adventurous, there's US Airways. Like Delta, you could argue that US Airways was actually profitable--or close to it--in the second quarter if we exclude noncash charges. US Airways will also benefit from lower fuel costs and sharply falling capacity.
"Just recently, in fact, the air carrier sharply increased its capacity reduction plans. It's a solid alternative to Delta for those willing to assume even more risk with a shot at even higher returns."
