Friday, April 11, 2008


Both the intermediate term and the long term history of CAL shows the anatomy of a sector turn. Stock market trends tend to be strong moves that overshoot, on both the upside and the downside. Once the share price has overshot its fundamental value, the price tends to test the new bottom or top. Once the bottom or top holds, then a new trend has been established. Again, the new trend will last until it has pushed the stock to the other extreme.

January 8, 2008, CAL made a new intermediate term bottom of $17.79 per share. In the current environment, this price has proven to be a clearing price. The price was incredibly low at around .13 times the sales per share. At this level, the owner of the stock, owns $7.70 worth of sales for each $1 invested in the company. In contrast, the darling of the market, LUV, which is a successful discount carrier, gets you only a dollars worth of sales per dollar invested. Should the net profit on CAL sales revert to the mean, the return on investment would be huge.

On March 17, CAL tested the low by trading at $17.92 per share. Another way of looking at this is that a huge buy program might be in place at $18 per share. A computer or two might be set to buy all the shares available below $18. On March 28, the next low was made at $18.40. This is an indication that other major investors have tried to accumulate shares at $18 or below and they have become aware that the "big buy program" is in place at $18.00. To buy shares, these investors have realized that they most pay more than $18. Today, April 11, the stock is trading at $21.80, 22.5% off the bottom.


The cyclical bottom was made in October of 2002. At that point the stock traded at $3.59; what a steal? In March of 2003 the bottom was tested at $4.16 per share. In August of 2004, the next bottom was at $7.80. The September 2005 bottom was put in at $9.03. The March 2008 short term bottom is also the continuation of higher bottoms that started in 2002. The increase in value from 2002 to today was 607%. The trend is not over. I expect another 600% gain before this move is over.


Ray Neidl of Caylon Securities has followed the industry for 30 years or so. I often read his comments. He is short term oriented so he can quickly go from a strong buy to a neutral position (neutral among analyst is often a euphemism for sell). Ray currently acknowledges the extreme turbulence faced by the industry but he also notes that traffic is unusually strong for what is commonly believed to be a recession. He says that airlines shares should be bought during the middle of recessions. He does not think the middle of this recession has been reached.

Neidl and the Chairman of Virgin airlines have noted that the bankruptcy of carriers is a good thing for those who desire to buy used planes. Planes are in high demand and in short supply. One of the reasons that CAL has thus far escaped the grounding of planes for inspections is because they have sold off their old planes from here to Russia. I suspect that many of the SKYBUS planes will be purchased by carriers in supper strong developing markets. Capacity in the USA is being reduced.

Compare the housing market to the airline market and you can see an interesting pattern. During the recession of 2001 housing sales held up very well. Coming out of the recession and for the next 4 years, housing sales and prices soared. Here we are in the "next recession" and airline traffic is still very strong. In particular, high dollar business traffic has remained strong. So far, the Chinese economy has defied gravity. Oil prices have remained high partly because, after one of the coldest winters on record, China appears to have resumed its double digit growth. The catch-22 is that strong China growth (not to discount the upcoming Olympic Games) will increase seat demand at the same time it keeps the pressure on oil prices. The price of oil per barrel was below $20 in October 2002. The 607 percent gain in the price of CAL over lapped a similar increase in the price of oil.

Ask the man on the street about the relationship between oil prices and airline stock prices and he is apt to tell you that if the price of oil goes up, the price of airline shares would go down. As Ken Fisher has written many times over many years, there is no statistically valid ratio of oil price to airline stock price. The way it works is in a period of strong demand, airlines and oil companies can generally raise their prices if most of their capacity is being used. The higher prices cause each of the industries to increase capacity. Once the capacity (or supply) catches up to the need (or demand) the price ceases to rise. A common phrase that describes this process is that "price cures price".

The current situation is that an economic slow down has started to slow the growth in demand for both oil and airline seats. Few people, including those who follow markets closely would be able to tell you that total US oil product demand hit its peak in 2005, four years ago. The average man believes US demand is still rising but the peak was in August of 2005. Because the airline business is much more volatile, the demand growth was huge until the slow down hit. The fear reflected in the share prices is that demand will be hit harder still during a prolonged recession. However, recessions are over by the time they are official and there are already signs that this slowdown is over. By the time it is commonly known that we are in a recession, stock prices race forward in anticipation of the good times ahead. The market made a low in January, that has since been twice tested.

When this slow down or recession is over, the demand for oil and airline seats will once again move forward, again, after the share price has already moved up. New airline capacity is being severely restricted by manufacturing problems. There are 1,000s of old planes being flown and it will take years for them to be replaced. The "news" is all about how oil production is restricted. The fact is that the current price is causing massive investment and massive substitution in the oil market but the supply of large airplanes is very tight. While it takes time for investments to produce results, investments made 3, 4 and 5 years ago are starting to bear fruit. Even if the price of oil goes up over the next several years, the price of airline tickets is likely to go up more.

The other key to capacity is that the major carriers have been successful at rationalizing their business. Now, if a 50 seat plane is needed to compete with a low cost carrier on a certain route, the "big boys" can place that plane on that route. The low cost carriers are now competing with another low cost carrier that happens to be a "partner" with a "big boy". Yesterday's preliminary ruling that allows NWA and DAL to share profits and losses on transatlantic routes is further evidence that the big carriers will be allowed to continue to rationalize all areas of their business. Unlike the days of deregulation and the years of turmoil that followed, planes will no longer fly on unprofitable routes simply because those are the routes permitted by the all knowing, all seeing, benevolent government. The King is dead, long live the rights of the little people!