Thursday, February 24, 2005


Mike Taylor (see his info at taylortree) and I have had a little fun discussing airline stocks.

Below are two charts. The first shows AMR (American Airlines) prices twice. The green line is the price relative to the price of West Texas Crude Oil. The second chart shows WTIC and the WTIC relative to the AMR.

AIR over OIL Posted by Hello (click on image to enlarge)

Note the price action of the two from 1994 to mid 1998. After oil spiked upward in 1994, AMR traded down until November. However, the AMR price went from $10 to $35 from November of 1994 to July of 1998. The WTIC run lasted from February 1994 until November of 1996. As you can see, there was more over-lap than divergence.

Now take a look at the bottoms in WTIC and AMR in early 2003. Since that time, both are up dramatically, with AMR up the greater percentage! I have not computed the r square but the two sets of data have a high level of correlation.

I am reminded of the question Papa John asked his kids and grandkids. If a chicken and a half lays an egg and a half in a day and a half, how many eggs does one chicken lay in one day? I invite you to comment with your answer.

Hint: to answer correctly you have to relate the correct variables.

In the case of Oil and Air, there is a common denominator. In a strong economy the air line business gradually turns strong and in a strong airline economy the cost of fuel goes up. In a weak economy the airline business is weak and the oil market is weak. As you can see from the charts, fuel leads the air lines.

Traders tend to miss this obvious relationship because they look at short term moves. On any particular day, if the oil market moves up sharply the whole stock market including air lines is usually weak. Day to day swings do not tell the whole story. It is common sense that fuel prices go up in a strong economy.

Trucking picks up earlier in the cycle than does air travel. In four years Yellow Freight (YELL) has risen from $15 to $60. YELL buys a lot of fuel. Its fuel costs have gone up dramatically in the past four years. We are talking truth hear about any commodity. The price of raw materials is only one part of the cost of a product. Look at the PPI and the CPI this very week. PPI is up more than CPI but company profits are soaring.

The investor who wants to make 10 baggers should look long-term and appreciate that air lines do well in the expansion phase of the economic cycle. Take a look at recent capex numbers and you will agree that we have moved into the expansion phase. The last time we went through an expansion phase, USAir bottomed at around $3 a share and peaked at over $65. I have to put around and over because I am posting from memory. It sure was a sweet ride.

I may buy USAir again if and when it makes it out of bankruptcy. For now, I own, CAL, DAL, NWAC and AMR. It would make me happy if UAL or USAir liquidate. I don't even think I would be hurt real bad if one of my "big four" is liquidated. The remaining players would be the survivors in a business that has extremely high operating and financial leverage. The money the survivors will make is enough to make your head spin.