Sunny Skies for U.S. Airlines

Shares of major U.S. airlines climbed Tuesday, after No. 4 carrier Continental issued bullish traffic and revenue figures for June

In news that comes as little surprise to travelers, Continental Airlines (CAL) says its planes flew at record loads in June, helping to boost revenues. In other words, the summer is shaping up as a potential good-news story for U.S. carriers, long plagued by pricey fuel and recurrent terror alerts.

Continental, the fourth-largest U.S. airline, said after the market close on July 2 that its June passenger revenue rose 1.5% to 2.5%, higher than most analysts had expected. On its mainline flights, revenue rose 3.5% to 4.5% over a year ago.

Passenger traffic rose 5%, while capacity was up only 3.4% over June, 2006. Its consolidated load factor—a measure of how many seats it filled on all flights—rose to 85.7%, 1.2% higher than in June, 2006. Continental's domestic mainline load factor was 87.7%, up 1 percentage point from a year ago, while international flights had a load of 84.4%, up 1.7 points. All the traffic data were records for June.

The numbers suggest that U.S. carriers are managing their fuel costs via surcharges and strategic purchases, while keeping a lid on how many seats they're flying. At the same time, most of the major airlines have been successful making fare hikes imposed last month stick in most markets. "The fundamental backdrop for the airline industry appears to be on the mend," Credit Suisse (CS) analyst Daniel McKenzie wrote July 2 in a client note.

The net effect? Airline stocks surged ahead of the July 4 holiday, with Houston-based Continental leading the way, up more than 11%, to $37.62, in the short session.

The effect spilled onto other airlines: US Airways Group (LCC) was up 7%, to $32.86; American's parent, AMR Corp. (AMR) gained 4.8%, to $28.36; Delta Air Lines (DAL) rose 3.4%, to $20.25; Northwest added 2.8%, to $22.75; and United Airlines parent UAL Corp. (UAUA) rose 2.4%, to $42.10. Discounter AirTran Airways (AAI) gained 3.1%, to $11.50. (Only Frontier Airlines Holdings [FRNT], which announced new turboprop flights to four cities from its Denver hub, fell on July 3. Frontier was off 1.1%.)

Soleil-Solebury Research analyst Jim Higgins boosted his rating on Continental to buy from hold, citing the financial improvement, and raised his target share price by $2 to $42. "We now see in excess of 20% upside in CAL shares and rate them buy," Higgins wrote in a July 3 note to clients.

"Given that we now expect a favorable tone to almost all airline stock prices, we believe multiples on CAL's 2007 earnings will be biased upward in anticipation of better times ahead," Higgins wrote.

While it's a summer of travel for many Americans—heavy demand—much of the current revenue picture comes from restrained capacity—supply. McKenzie noted that Continental, for example, grew domestic capacity only 4.5% in June, compared to 8.2% in May.

"The implication: consensus earnings per share (EPS) of $1.67 too conservative," McKenzie wrote in a note to clients. He has a target of $53 for the stock.