Surprisingly Smooth Skies for Airlines

The oil-price surge has hit airline stocks in recent days. But after their initial declines, S&P says some look ready to weather the storm

From Standard & Poor's Equity Research

Airline stocks got caught in a downdraft on Apr. 17 amid a fresh surge in oil prices. But despite crude's continued ascent, fundamentals appear to be improving for airlines that are highly ranked by Standard & Poor's Equity Research. Many carriers are reporting earnings during mid- to late April -- which, S&P thinks, should provide good purchasing opportunities for select airline stocks.

The Apr. 17 decline in airline stocks came as global economic tensions sent light sweet crude soaring to new levels, surpassing the highs seen immediately after Hurricane Katrina. The May oil contract eclipsed $70 per barrel; the June contract neared $72.

The news appeared to hit S&P's favorite airlines hard. The stock of American Airlines' parent, AMR (AMR), which carries a 5 STARS (strong buy) ranking from S&P, closed 8.8% lower. But the shares regained some ground on Apr. 19 after the company posted a first-quarter loss of 49 cents a share, which was narrower than the Wall Street consensus forecast of a 77-cent loss. AMR ended the quarter with $4.8 billion in cash.


  The Street expects Continental Airlines (CAL), also ranked 5 STARS, to report a loss of about 77 cents a share when it releases results on Apr. 20. Continental's shares closed down 10.8% on Apr. 17.

Four other airline stocks ranked 4 STARS by S&P were also bid down on Apr. 17. Alaska Air (ALK) lost 1.6% of its share price. S&P expects the company to report a quarterly loss of 50 cents per share when it releases results on Apr. 20. AirTran Holdings (AAI) closed down 6.1% and will report earnings on Apr. 27; the S&P estimate is for a profit of five cents per share, while the Street expects a seven-cent loss.

Southwest Airlines (LUV) shares shed 4% on Apr. 17 ahead of the company's planned Apr. 20 earnings announcement; the S&P estimate is for EPS of 12 cents. SkyWest (SKYW), which reports profits in early May, was relatively unscathed in the Apr. 17 rout, losing just 0.73% of its share price. S&P expects SkyWest to earn 62 cents for the quarter.


  Jim Corridore, S&P's equity analyst covering the airline industry, is "concerned" over rising oil prices, and notes "a continued rise in energy prices would be a material negative for the stocks, [but] we think fundamentals other than oil prices are improving in airlines." When outlining his positive fundamental outlook for the high-ranking companies he follows, Corridore points to increased passenger loads and rising airfares, as well as efficiency gains and cost cutting.

Higher oil prices might actually drive faster and larger increases in airfares and lead to more aggressive steps to cut capacity, which could aid carriers such as Continental, for example. Corridore says that his forecast "for a rise in airfares reflects likely capacity cuts by competitors, which could allow for an improved pricing environment. We expect the recent trend of steady fare hikes by the carriers to continue in 2006, as airlines look to offset rising oil prices and as passenger travel demand and high load factors should support higher average airfares."


  In AMR's case, more passenger traffic and fewer competitors fuel Corridore's positive investment stance on the company. He notes, "We expect average airfares to be helped by improved pricing power, as AMR has been successful in getting fare increases to stick. In addition, we think competitors are likely to cut capacity in 2006, leading to an improved pricing environment." After the company's Apr. 19 earnings release, Corridore is encouraged by the year-over-year improvement in AMR's financial results heading into what he expects to be an exceptionally strong summer travel season.

Although it remains to be seen how long the airlines can continue offsetting the impact of higher fuel prices, S&P thinks some carriers seem better positioned than others to weather oil's climb to ever-higher altitudes.

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