Airline stocks used to be “death traps” for investors in the past. A recession or a downturn of the sector was sufficient to erase the profits of several years and drive some companies out of business. That’s why legendary value investor Warren Buffett had always advised investors to stay away from these stocks. However, thanks to a series of bankruptcies and mergers, the sector has greatly consolidated. Thus the four major U.S. airlines–American Airlines (AAL), Delta Air Lines (DAL), United Continental (UAL) and Southwest Airlines (LUV)–now have an 80% total market share and enjoy wide margins.
This helps explain why Buffett changed his stance and purchased significant stakes in the four major U.S. airlines two years ago. All four airlines are among Buffett’s top 20 stock holdings.
Airlines also benefit from a secular trend, namely the increasing tendency of people to travel more and more often. According to IATA, the U.S. and the global air traffic are expected to continue to grow by 2.8% and 3.7% per year, respectively, until 2035.
Due to their high debt levels and the high cyclicality of their business, airline stocks trade at markedly low, usually single-digit price-to-earnings ratios, which are less than half of the price-to-earnings ratio of the broad market. But this does not automatically make them good investments–investors should check the growth prospects and the risks of each individual airline and then decide whether it is a bargain.
In this article, we will compare the expected 5-year returns of the four major U.S. airlines found in the Sure Analysis Research Database, which ranks stocks based upon the combination of their dividend yield, earnings-per-share growth potential and valuation changes to compute total returns.
Best Airline Stock #4: United Continental
United Continental owns United Airlines and Continental Airlines and operates more than 4,500 daily flights to numerous domestic and international destinations.
In recent years, airlines have also greatly benefited from the depressed jet fuel price. This cost is one of the most important determinants of their earnings. However, the price of oil has strongly rebounded since last summer. In addition, as the supply glut has been eliminated and the oil market has become tight, the prices of oil and jet fuel are likely to remain elevated for the foreseeable future.
Despite a 26% increase in its fuel costs in Q1, the company grew its revenue and its earnings by 7.2% and 8.3%, respectively, thanks to its strong performance in Atlantic and Latin America. In addition, the company reduced its share count by 9.4% and thus grew its EPS by 19%. Overall, United Continental has maintained its strong performance despite the headwinds facing its business.
Moreover, its management reiterated its positive long-term guidance in the last conference call. It expects to grow the earnings per share from approximately $7.73 this year to $11.00-$13.00 by 2020.
Source: Investor Presentation
Given the rising fuel costs and wages and the decreasing fares, this guidance is likely to prove somewhat optimistic. On the other hand, the company takes advantage of its cheap valuation and executes very efficient share repurchases. In the last three years, it has reduced its share count by 7% per year.
