Saturday, February 18, 2006


Air Canada reports record system load factors for January 2006


Back on February 7, 2006, Air Canada reported a 7.7% increase in traffic and a system load factor of 78.1%. "The mainline carrier flew 2.7% more revenue passenger miles in January". The load factor was the highest in history in the month of January.

Folks, there is a simple concept that you need to make sure you understand. When a business with high operating leverage experiences high demand for its product, it is able to sell more product at higher prices and the profit margins expand exponentially. The math is very simple.

Which would you prefer: for 500 people to owe you an average of $300 or for 530 people to owe you an average or $500. The first group would owe you $150,000 and the second group would owe you $265,000. Multiply these numbers by 300 planes flying almost 3 trips per day and the revenue difference is 103 Million Dollars per day.

Clearly my numbers are just examples drawn out of the air. The increase from $300 to $500 does not happen overnight. However, prices of seats do increase sharply when demand is very high.

My CPA friend, Lamar Jones, has been playing an interesting game. He regularly goes on-line to book a flight or two just to see if it is available and to see the price. He has found that airline seats are getting harder to find even at higher prices. A couple of weeks ago, I viewed a research report from JP Morgan that showed overall transportation prices rising annually at better than 12%. Airline seat prices are more volatile than freight prices at railroads. Railroads are doing well. My family has enjoyed nice runs in Norfolk Southern and in CSX railroads but nothing like the runs in AMR and CAL.

The airline shares we purchased about 6 months ago for around $9 are now selling for around $22. It ain't over yet!

Standard and Poors reports that airlines trade at 20 times earnings or more when they are in "good times". S&P estimates that CAL.
will earn $1.75 per share in 2006 and will trade for $37 per share, about 21 times earnings.

A lot of traders use oil prices as the excuse to not buy airline stocks; not a smart position to take. While I hope and expect oil prices to continue to moderate (just last week significant oil discoveries were made in Libya and in Angola), high prices could be exactly what AMR and CAL.
need. High oil prices could aid and abet the liquidation of NWAC or DAL. CAL.
and AMR would pick up market share should either of these carriers liquidate. Since CAL.
code shares with NWAC, it would be easy for them to service many of the routes available.

I am not routing for liquidation. It is an economic reality that labor prices are inelastic on the way down. It is really hard for anyone to accept a wage cut. In the days of heavy regulation of airlines, non-rational wages and rules crept into the system. The same thing happened in the rail road business. It has been a gut wrenching process to rationalize these industries. The unions at NWAC and DAL face a difficult choice, they must help these carriers lower their operating costs by taking pay cuts and accepting new work rules or they must join the ranks of the unemployed.

I think DAL and NWAC will survive bankruptcy. I think they will emerge as slightly smaller carriers but would not be surprised if there is not additional consolidation in the industry.

This situation drips with irony. At a time when airlines are flying the most full planes ever before in history, several carriers are fighting for survival. Worldwide, business travel, the real money maker for airlines, is at the highest level in history. The rates on first class and business class seats are soaring. Serious money is about to be made in the airline business.

A few years back, when I purchased Nextel shares (now merged with Sprint) I had to explain again and again that the negative book value of the company was not a problem. The stock went up about ten times in value in about 3 years. It was a glorious Ken Fisher bucking bronco ride. CAL.
is a similar situation. The company had a negative tangible book value last year and was bleeding cash. At current fuel prices, I believe it will have operating profits of better than $3 per share. Cash flow will be significantly larger than debt servicing needs.

NXTL surprised a lot of folks when it started buying up debentures at around 50 cents on the dollar. CAL.
should be able to achieve significant interest savings by 2007 while enjoying revenue growth of 25% or more (S&P forecasts 2006 passenger revenue growth of 22% but I think they are about to miss on the low side).

My family owns a nice chunk of CAL.
. We also own AMR and LCC. The extra good news is that 27% of the CAL.
shares available have been sold short. While I must admit that there likely a number of arbitrages going on, eventually those who are short the stock will need to cover.

I mentioned that labor prices is inelastic on the way down. I have rightfully implied that seat prices are elastic on the way up. Wait until you see the shorts all trying to cover to see real elasticity of demand. I hope my assistant will post a chart of CAL.
from 1995 to 1996 so you can see what can happen when the airlines turn.

In the business world, anything can happen. KLM reported great traffic growth the other day and the stock went down. The growth in demand will eventually be over taken by the growth in capacity. Boeing just set record airline sales. In about three years, Boeing will be pushing many new planes out the doors. At that time, CNBC will be reporting daily about the growth in traffic and the turn-around in the airline business. Buy your shares now and you will be ready to enjoy all five years of the bucking bronco ride, not just the last two when CNBC and others are hyping the industry.