Thursday, December 22, 2005

WOW! American Airlines fuel costs will be less than expected - Airlines - Transportation - Company Announcements


The prospects for the American Airlines (AMR) and for Continental Airlines (CAL) keep being upgraded. Calyon Securities now expects (AMR) to lose 30 cents per share in 2006 versus a prior expectation of a loss of $1.58.

Several other analysts have made much brighter projections. The 2006 target price of the stock at S&P is $40 per share. Whereas Prudential Equity Group just raised its target from $15 to $35. Bob McAdoo at Prudential now estimates 2006 earnings to top $3.50 per share.

The situation is one of projected strong revenue growth on top of the dramatic costs reductions put in place the last few years. The company projects 2006 revenue growth of about 13%. The reason for the wide range in earnings projections is because of the wide range in estimated fuel costs.

Earlier this year, AMR projected, 4th quarter, fuel costs to be an average of $2.34 per gallon. The revised estimate is $1.73 per gallon. The difference of 61 cents per gallon is a big number for a company that might use 3.7 billion gallons of fuel in 2006; an annual cost difference of $2.25 Billion Dollars!

My favorite airline is Continental . This company will save about $500 million in labor costs in 2006. Should it also save 61 cents per gallon in fuel cost, the net profits could exceed $3 or even $4 per share in 2006 and possible $6 to $8 in 2007.

The risk of higher fuel prices and the negative talk about airlines has kept the public out of these shares. Many stock brokers have been prohibited from recommending the shares for the past several years. Now that estimates are being raised, these restrictions are gradually being relaxed.

These airlines are 98% or more owned by investment institutions. Even many mutual funds have restrictive covenants that prohibit ownership of distressed or turnaround situations; the levels of distress are declining rapidly. Suddenly American Airlines (AMR) is estimating year end cash on hand of over $4 Billion Dollars. Continental is now looking at around $1.9 Billion in cash on hand after catching up on pension payments to the tune of $237 Million Dollars.

The turn-around story is not widely known, whereas most folks partially know the bankruptcy story. The important part of the bankruptcy story for AMR and CAL is that capacity is being cut dramatically at the bankrupted lines. The great opportunity in AMR and CAL are a direct result of the bankruptcy of competitors. Like my great grandpa used to say, "The time to get into the chicken business is when everyone else is getting out." His explanation included the ideas that the cost of chicken feed would go down while the price of the grown chicken would go up.

The AMR and CAL three year potential of reaching $8 per share in earnings and PE multiples of 20 are real possibilities. In other words, investors who buy either of these companies now may hit a walk off home run. Those who average up on the way up should make serious money.

As a retired investor, I write for the education and entertainment of my readers. As an amateur investor, I am not allowed to make recommendations. As an investor, I have made my share of mistakes. I have also helped a number of folks hit some huge winners. One of my best and most controversial moves was when I borrowed heavily in 1984 and used the borrowed funds to buy 30 year US Government Bonds that offered yields to maturity of about 14%. At the time, other investors thought I was crazy because inflation had been running at an even higher rate. In the years that followed, the rate of interest on the borrowed funds declined dramatically while the value of the bonds increased dramatically.

My current belief is that the international airline business is going through a dramatic cyclical turnaround. Study the history of airlines to discover an incredible record of boom and bust. Some of the all time great fortunes were made during the years when Pan Am and TWA controlled the majority of international routes; neither firm survived the deregulation process that started in 1979. In the 1990's, Warren Buffet rode US Airways from $20 a share down to about $4 per share before the stock zoomed to $65 per share. In his report to share holders, Warren related that the roller coaster ride was almost as much as he could take.

Warren's original purchase of $21 convertible preferred stock paid him a 9% yield but even that dividend was suspended for a couple of years. Warren eventually made about 300% in capital gains plus the 9% dividend; an incredibly good total return in, as best I can remember, about 5 years total holding time. Most investors made less than the 9% during those years.

Today's situation is similar to what happened in the 1990's. When the business expansion kicked off around 1995, the fare for the average seat was pushed up by business travel demand. In December of 2005, the average seat fare is up about 10% year over year. Business travel boomed in 2005. The US is now a part of a global economy like no other time in our history. Bigger gains are projected in 2006.

Most importantly, load factors are at record levels. It cost almost the same money to fly an empty seat from New York to New Delhi as it cost to fly a full seat. The revenue difference is probably 100 times the cost difference! Another way of understanding the situation is to appreciate that airlines have a very high break even point but, after the break even point is reached, more than 90% of marginal revenues are profits.

Check the schedules, I believe you will find that AMR operates the only flight from Chicago to New Delhi and Continental Airlines operates the only flight from New York to New Delhi. Check all the other airlines schedules, you will find that you can't get there flying Southwest or Jet Blue.


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