Thursday, December 01, 2005


Since 1971, the average S&P 500 stock has increased more than 12 times in value. The most successful US Airline, AMR Corp, has increased only 1.5 times in value. It is now time for the US carriers to do well.

When the airlines were deregulated in 1979, upstarts had an easy time of taking market share. The reason was the built in fixed costs of the major carriers.AMR has lead the way in recent years to get their costs down. They have even replaced glass mirrors in the bath rooms to reduce weight and fuel costs. Consider the pain of the DAL pilots right now.

DAL pilots agreed to salary cuts of 39% earlier this year. These cuts still did not make the firm competitive with AMR. The company is now demanding additional cuts of 19%. The compounded effect is about 47%. With cuts of this size can you see why discount carriers are now being met head to head?

LUV, for one, can no longer expand rapidly. LUV has been smart enough to use its extra cash to pay off debt rather than to try to muscle up against the majors. LUV has a considerable amount of fuel hedged for years to come, 70% in 2006, 55% in 2007 and 35% in 2008. However, the value of these hedges is built into the price of the stock and they could turnout to be worth substantially less if fuel prices come down.

AMRis making high returns on its long-haul flights. It is doing especially well on international long-haul flights. Should the price of fuel come down 20 cents per gallon, AMRcould make close to $5 per share in a years time. Clearly, it may take almost a year for fuel to come down another 20 cents. Clearly, it would be worth holding the stock for a year if the 20 cent drop comes. If it doesn't, in the face of strong business travel demand,AMR might have healthy earnings anyway.

After 26 tough years, it is finally AMRturn to do well. LCC is a little cheaper based on enterprise value because so much of its debt was dropped off in bankruptcy. CAL was even more leveraged but the sale of new shares has increased CAL solvency but reduced the upside. I think all three will see good times for the next three years.