Thursday, November 24, 2005


Would you like to see a magic trick? Do you know how to turn a nickle into 70 cents? I know how and I am willing to tell!

Operating leverage is a neat trick; legacy air carriers have operating leverage. This means that if they increase their revenues (or yield) a little, their earnings go up a lot.

For example, according to JP Morgan, if AMR, CAL or LCC were able to lower their fuel cost by a nickle, their earnings would go up by about $.70. Guess what? Jet fuel prices dropped $.07 today! Guess what? In the past month or so, since many a projection was made, jet fuel prices have dropped about $.60! Guess what? Jet fuel supplies are now higher than before hurricane Katrina! The decline in fuel prices may continue. Instead of losing a little money, these carriers may make a lot of money. AMR and CAL could easily make $3.50 per share in 2006. LCC could easily make more.

Should AMR and CAL trade at 10 times earnings and earn $3.50 per share in 2006, we might be talking about $35 stocks; about 100% higher than current prices. Believe me, I know that AMR and CAL have already made big moves. Riding these stocks for the past three years has truly been a Ken Fisher "bucking bronco" ride.

Ken wrote about bucking bronco's in Forbes during the recession of 1990-91. I heard the message and learned from it. I do not know Ken's attitude about airline stocks but Ken is bullish on the market. He and other smart folks like Don Hays, Ed Yardeni and Harry Dent have noted that many corporations are currently able to increase their earnings buy issuing corporate bonds and using the money to buy back shares.

Stan Salvigsen used to write about clearing prices. The current situation is a great example. If a corporation can issue bonds, buy shares and increase earnings, why not? Ironically, one of the concerns that has driven folks away from stocks is that the US Government is currently practicing the same strategy. We are currently borrowing money at such low rates that we are profiting from it. Those who are whining about the trade deficit do not realize how profitable it is! Ken has written similar statements about the government deficit.

As always, statistics can be used to tell big lies. A common lie being told today is that Americans are more in debt than ever before. The problem with the statement is that it ignores the increase in American wealth. It is like saying that the person who owes $150,000 on his home is in debt twice as much as the fellow who owes $75,000 on his home, when the home of the person who owes $150,000 is worth $500,000 and the home of the person who owes $75,000 is worth $150,000. It also ignores the incomes of the two homeowners. If a person owes $150,000 but has an annual income of $150,000, he is probably in pretty good financial shape. If the person who owes $75,000 is retired, he may be in a bind.

Now is the time to turn nickles into dollars. It may take a few years. It took 29 years for the airlines to rationalize their business. Deregulation has been tough. None of us should blame the airline employees for bargaining for excessive wages and benefits during the regulated oligopoly phase. We can all understand why Delta and NWAC employees are trying so hard to hang onto excessive payments. We can also appreciate how much more affordable it is to fly.

Early in my career, I was the General Manager of a credit union. The motto of the credit union movement is, "Not for profit, not for charity, but for service". This simple concept has been routinely abused by many a credit union board of directors. It is a simple concept but only a relative few understand. The common mistake is to assume that credit unions are very different from other businesses. The reality is that every business needs to keep its net operating costs as low as possible and to charge a competitive price to the customers. The margin between the costs and the prices must be used to "fund" the business. Credit unions must make a "profit" to support growth of services. New employees must be hired, office space must be acquired, equipment must be purchased. Some credit unions practice charity by loaning money below the cost. Others make excess "profits" while performing a disservice to the customers.

The airline business is finally close to being rationally structured. New entrants can no longer gain business rapidly by under-cutting the wages of established companies. The middle class American traveler is no longer paying airline employees triple their own wages. Investors in the companies can now rationally expect to receive a return on their invested capital. The free market is not perfect but it consistently beats all other systems. Those airline employees who retired wealthy in the past many years are entitled to their fat pensions. Those who invested their earnings in the US Air, UAL, DAL, NWAC and other failed carriers cannot expect a refund. What was gained is gained and what was lost is lost. The smart investor will catch the long ride up no matter if he was on board for the long ride down.