Wednesday, December 07, 2005

Airline Stocks: AMR shares jump, lead sector higher - Airlines - Transportation - Markets/Exchanges - Market News

Merrill Lynch has joined the growing list of "big boys" who are recommending American Airlines (AMR). The stock is up 90% this year and about 1200% off the three year low but it is still nice for Merrill to join the party. MarketWatch, an online arm of the Wall Street Journal, reports that Merrill analyst, Michael Linenberg said that he expects AMR to earn a profit next year of $1.15 a share. He boosted the price target on the stock to $25 from $18. Prior to the boost, he had a forecast of a loss of $3.50 per share.

My family has over-weighted airlines in our portfolio, we hold airlines in our Stock of the Week portfolio and we have added to holdings several times during the past year. Our position is up 45% or so in the past two months!

You can see why we love a change in earnings outlook for 2006 from -$3.50 to +$1.15. How can one change ones mind to such a degree? Did AMR do something last week that sparked such a change? NO!

The fact is that all year long, US carriers have been operating at the highest load factors in the history of the business. Business travel in a strong economy has been at record levels. The one big piece of news yesterday was that DAL, one of several major airlines flying under chapter 11 bankruptcy protections, announced that it had sold 10 of the new planes it had on order. DAL, NWAC and UAL continue to cut back capacity while in bankruptcy but the planes are being recycled to other carriers. Thus the main impetus for increased revenues is the rise in demand, not a cut back in supply.

According to Merrill, "a modest pull-back" in fuel prices was a factor in their adjustment. Again, the timing is puzzling. Fuel prices have pulled back substantially from the highs, from about $2.35 per gallon to about $1.70 per gallon but the past 6 days in a row fuel prices are up.

It seems one should consider using the Merrill recommendation as a contrarian indicator for the short-term. All though I will certainly not recommend to any of my friends and family who own the stock to sell, but I will not suggest they buy more until the market has digested the Merrill recommendation. In addition to Merrill, Lehman, JP Morgan and Standard and Poor?s have strong recommendations on several carriers including AMR.

Fundamentally, I believe the stock can hit $45 or higher in the next couple of years. The $1.25 earnings forecast by Merrill will be way off the mark if fuel prices continue to moderate. JP Morgan suggest that earnings could easily hit $4 per share or more in 2006 if fuel averages $1.60 or less for the year.

Note that another oil driller increased its proven reserves by millions of barrels yesterday. With many increases in central bank rates occurring day after day, one can anticipate demand destruction sufficient to hold down prices long enough for new supplies to come on line. New supplies are trickling-in but the pace should quicken now that the oil rig count has zoomed. I have not checked the Baker Hughes rig count in the past couple of weeks but from memory I know that the increase over the past three years is heartening.

If you have no exposure to the airline sector, you should consider buying CAL, AMR or LCC. LCC is the cheapest based on enterprise value but CAL is the most levered to oil and to the economic boom in international travel. CAL has already moved from $5 to $17, 340%, but it also could trade in the $40's or $50's in a couple of years.

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