IB Net Payout Yields Model

Time to Short the Airlines?

Listening to CNBC [Airline Profits Take Off] this morning and there feature on the airlines makes me think its about time to go short. Anytime people get bullish on them its time to get out or go short. US airlines have historically lost money and nothing has stucturally changed. Sure they charge a bunch of extra fees now, but that only offsets the lower ticket prices. There biggest issues continue to be that everybody wants into the industry and every time CNBC does a feature on profits the unions automatically line up for their portion. Airlines can lose billions for 5 straight years and the unions will want new contracts the year they make $50.

Reading through this article in the Ft Worth Star-Telegram just reminds me of the reasons you don't want to invest in domestic airlines. The CEO and upper management of American Airlines (AMR) is heavily engaged in discussing contracts with the various unions instead of working on developing and implementing a profitable growth plan. Any company engaged in such discussions can never be anything other then a trading buy.

Earlier this week the International Air Transportation Association (IATA) reported that worldwide airline profits would equal $8.9B this year up from a previously forecast of $2.5B. Most of this profit is suppose to come from Asia at $5.2B while Europe expects to still lose money the US will make around $3.5B. Unfortunately though IATA expects 2010 to be the peak of the cycle with 2011 profit falling to $5.3B. Highlighting the main issue with airlines: as soon as they make money more competition jumps on board or expenses jump from being unable to limit or reduce union benefits.

All in all, the only airlines worth investing might be in Asia or Latin America. Though Stone Fox would rather invest in airplane leasors and specifically AerCap Holdings (AER). AER expects to make roughly $2 this year and only trades around $12. They'll benefit from growth in Asian markets and the stability in the US market. So while CNBC can pump up the domestic players making a few dollars back after decades of losses, we'll stick with a company that even made money in the financial crisis in 2010.

  • Demand and Capacity: Rapidly improving demand has pushed traffic 3-4% above the pre-crisis levels of early 2008. Demand in 2010 is expected to grow by 11% (stronger than the previous forecast of 10.2%) while capacity will only expand by 7.0% (up from the previous forecast of 5.4%).
  • Fuel: The revised outlook maintains an average full-year crude oil price of $79/barrel. However, excess refinery capacity is pushing the “crack spread” slightly lower than previously anticipated resulting in lower prices for jet fuel. Even with stronger traffic the total fuel bill is now forecast to be $137 billion, $3 billion lower than forecast in June. Fuel continues to account for about 25% of industry costs. (if oil soars above $79 then the airlines will make a lot less leaving fuel as the largest risk factor)
  • Asia-Pacific: Asia-Pacific carriers are expected to post a $5.2 billion profit. This is better than the $3 billion recorded during the previous peak in 2007 and double the previously forecasted $2.2 billion. The strong improvement is based on strong market growth and yield gains.  Renewed buoyancy in air freight markets has been particularly important for airlines in this region, where it can represent up to 40% of revenues. The 23.5% improvement in high volume intra-Asia premium traffic, due to a surge in business travel, is another of the driving factors.
  • Europe: Compared to the June forecast, the prospects for Europe’s carriers improved from a loss of $2.8 billion to a loss of $1.3 billion. The gains are largely attributed to traffic into Europe, boosted by the low currency which has stimulated exports and improved the air cargo business. Continuing economic weakness in the European economy and faltering consumer confidence continues to depress originating passenger traffic.
  • North America: North American carriers are now forecast to make $3.5 billion (up from $1.9 billion).  US airlines cut capacity significantly as fuel prices spiked in 2008 and maintained a cautious approach to reinstating capacity to the market this year. The US economy and the resulting freight and air travel growth have grown at a better pace than in Europe. As a result, US airlines have seen a much larger rise in yields than other regions.
  • Latin America: Latin American carriers continue to benefit from very strong regional economic growth particularly in the south of the region, boosting freight, travel and profits. The profit forecast has improved slightly from $900 million to $1.0 billion.
  • Middle East: Middle Eastern airlines have benefitted from strong regional economies and an expanded share of long-haul markets. Unlike the previous two years, capacity has been added at a slower pace than demand growth in 2010, raising load factors and helping profitability. Carriers in the region are expected to see their profits rise significantly from $100 million to $400 million.


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