Thursday, March 23, 2006

Legacy Airlines Are Ready For Take-Off -

Legacy Airlines Are Ready For Take-Off -

Forbes reports that Goldman Sachs Analyst, Glenn Engel, has bumped his earnings estimates for several airlines. The article is a bit twisted. It starts with a headline about legacy carriers, follows with a report of stronger than expected earnings for AMR , CAL, LCC and NWAC but then goes on to suggest that domestic revenues is where the action is.

I strongly disagree with the point about domestic prospects relative to international prospects. The action in today's market is a direct result of extremely strong international trade and therefore growth in international traffic. It is the re-deployment of assets to international venues that is dragging the domestic market along for the ride. Carriers such as DAL have cut domestic routes to add to international routes. Company after company, including Siemens and Dell have recently announced expansions in India or China. The airline traffic growth action is in international flights.

Sure, the move of assets to international routes does add to the competition. The Continental growth in transatlantic revenues was in the area of 22% last quarter! After three relatively slow years, orders for new planes set a record last year. These planes will be delivered in 2008. A much larger portion than normal will be delivered to the Asian market.

Engel raised his 2006 and 2007 estimates for CAL, to $1.70 and $3.55 respectively. The 2006 bump was 21%. In my opinion both estimates will prove to be low; it is simply hard to appreciate the difference in revenues from planes with a few empty seats to planes with no empty seats. The price of all seats is more if all seats are projected to be full. Another way of saying this is that in the short to intermediate term, the fare set for any particular flight has absolutely nothing to do with the cost of providing the service but has 100% to do with the demand for the service.

So far, in the month of March, CAL, is operating at an unprecedented load of over 80%! To achieve a load factor of 80%, an airline has to fly a large majority of its flights with zero empty seats. Having operated an ocean front beach rental business for 20 years, I know what happens to prices when occupancy is very tight. Unfortunately for the internet shopper, the give-aways disappear. For the past 18 months or so, CAL, has joined the other carriers in regular fare increases. Even after 19 price increases, the seats are full. Expect fare hikes to continue. It may sound Machiavellian but if all seats continue to be full, then the airline is not charging enough.

The Standard and Poors estimate set last December tops the Engel estimate by 14 cents in 2006. Furthermore, S&P reports that during the "good times" in the airline business, airlines can easily trade at 21 times projected earnings. Using Engel's lower numbers, 21 times gives one price targets on CAL, of $35.70 in 2006 and $74 in 2007! S&P has a 2006 price target of $37.

This morning, Express Jet showed up at the top of the list on our Stock of the Week value screen. The stock was a big winner today. However, I asked Sandra to pull the recommendation because I believe the action is truly in the international markets. Domestic revenues will rise but frequent flyers generally want to accumulate their miles where they can be used internationally. Express Jetis too dependent on the good graces of CAL, and other international players for my taste.

My regular readers already know that I am a fan of Ken Fisher. I used Ken Fisherphilosophy when I rode the Nextel bucking bronco from $3 to $25 dollars and I am using it now on this fantastic CAL, "Ken FisherBucking Bronco" ride. Ken says that if you can find an economic situation where you have the minority opinion and where you know you are right, then you can make a pile of money. It is with some sadness that I witness the perception starting to turn.

Just a short time ago, the "talking heads" were willing to boldly state that one should never own an airline stock. Recently the boldness has started to fade. For example, Pat Dorsey with Morningstar, recently stated that airline stocks should not be part of your long term holdings, he would not touch the stocks but he believes the cyclical move could last awhile. With my first grand daughter due today and with the pressures generated when one is closing and selling a business, I have missed most of the recent Mad Money shows. Therefore, I do not know if Jim Cramer has capitulated yet. Never-the-less, it is clear that attitudes are starting to change. The press about airlines is still very negative with talk about everything from fuel prices to bird flu, but more and more one sees articles about better earnings forecast. Even the positive articles about improved earnings tend to "blame" the earnings on gimmicks such as charging more for the emergency exit seats.

The good news is that these stocks, AMR and CAL, in particular, still have a long way to go. Institutions still own about 95% of all shares outstanding and there are substantial short positions in each stock. There are imperfect arbitrages involved in some of short positions. I have not studied the exact nature of this but from the SEC statements one can see that there are convertible securities involved. The projected dilution from conversions are offset by reductions in interest costs. It appears that some of the short positions are naked or at least skimpily dressed with option hedges.

I plan to invest aggressively in these stocks until the public ownership rises to 25% or more. This will require a lot of positive press. It is hard for many investors to average up. The almost Pavlovic response of most investors is to want to sell when they buy a stock for $7 and it trades in a couple of years at $28, most investors would not even make it to $28. My friends and family accounts added shares last September at $9 odd, last October at $11 odd, at $17 odd in November or December and at $21 and $23 odd in January and February. The most recent purchase were made today. We expect to be adding shares next year at $50 or more. The shares purchased at $7 are wonderful and we can only wish we had had the money to buy more but the thing to do now is to buy as many as is reasonable at today's prices.

This morning, we added to our Yahoo position (we believe Yahoo , Google, EBAY and MSFT. are going to virtually take over the telephone business). So, while we are not a one trick pony, we do like CAL. John Maynard Keynes once said that perfect diversification is equal to zero profit. We are loaded with CAL, and AMR and are enjoying a wonderful bucking bronco ride. We are holding on for dear life and enjoying every moment.