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Will Airlines Ever Be Profitable Again? + Vic Wisemann’s Thoughts on: AMR, UAUA, CAL, LCC, DAL, LUV, JBLU, AAI

Vic Wisemann
InvestorsObserver
Featured Contributor

As some of you have probably guessed, I am a numbers kind of person. There are numbers all around us and they tell stories to anyone who will listen. I love to listen to the numbers speak, though I don't always understand what they are saying.

In the airline industry, the numbers are not saying very nice things at the moment. The International Air Transport Association (IATA) recently revised its airline financial forecast for 2009 to a global loss of $9 billion. This is nearly double the association’s March estimate of a $4.7 billion loss, reflecting a rapidly deteriorating revenue environment. The group also revised its loss estimate for 2008 to $10.4 billion from the previous estimate of $8.5 billion.

Scheduled traffic results for May showed passenger demand declining 9.3% compared to the same month in the previous year, while freight demand was down by 17.4%. International passenger load factors stood at 71.2%, down from 74.5% recorded in May 2008.

The 17.4% decline in international cargo demand is a relative improvement compared to the 21.7% drop in April. Since December 2008, cargo demand has been moving sideways in the -20% range. This is one of the first physical signs of the economic recovery being anticipated in equity markets.

Read on to see how you can get high flying profits from the low flying airline industry

Airline traffic fell again in June, providing another sign that most carriers are likely to report large financial losses for the second quarter. A downturn in business travel has robbed the airlines of their best customers. They've compensated by cutting prices to attract leisure travelers, but the math just doesn't work out.

One by one, all the major U.S. carriers reported June results and several reported double-digit declines in key financial measurements. All the leading U.S. airlines reported that June traffic fell compared with the same month last year. The average drop at the biggest eight companies was 6.1 percent.

The sharpest declines were at AMR Corp.'s (AMR) American Airlines and American Eagle, off a combined 7.9 percent; and UAL Corp.'s (UAUA) United Airlines and its regional affiliates, down a combined 7.5 percent.

Airlines measure traffic in miles flown by paying customers, a figure that doesn't take into account how much the passengers paid for their tickets. But other statistics do consider price, and they are telling a sad story for the airlines.

Continental Airlines Inc. (CAL) and US Airways (LCC) each said that unit revenue (sales per available seats times miles flown), a closely watched measurement of financial performance in the industry, fell about 20 percent from June 2008.

These declines in unit revenues are driven by weaker demand for business travel and lower leisure yields as a result of the global economic recession. American, the nation's No. 2 airline operator behind Delta Air Lines Inc. (DAL), said in a regulatory filing last month that second quarter unit revenue would be down by 16 percent to 17 percent for the entire second quarter. Southwest Airlines Co. (LUV) said unit revenue in June fell 9 or 10 percent.

Discount fliers like Southwest, JetBlue Airways Corp. (JBLU) and AirTran (AAI) appear to be holding up better financially than bigger rivals because consumers think of them first when looking for cheap fares, and because their domestic networks are insulated from the plunge in international travel. U.S. airlines pushed through two fare increases in June, which could lead to better unit revenue in July and August.

Airline stocks have disappointed investors for decades. That's partly because earnings are notoriously difficult to predict. Analysts have to account for business travel spending, fuel price spikes, labor disruptions, bankruptcies, accidents and the threat of terrorism.

Airlines are largely a commodity business with limited pricing power. As energy costs rise, they must generate more revenue to offset higher prices for jet fuel. The primary path to higher revenue is fewer seats. By cutting capacity, airlines can more easily boost ticket prices. Given the myriad factors at play, it's unquestionably difficult to make money in airline stocks.

This industry is one where hedged option strategies are a good way to generate income while keeping risks down. Looking around the universe of airline stocks, none strike me as fantastic buy-and-hold candidates.

The shift in ticket sales from business to leisure will most likely lead to lower revenues as the airlines will not be able to strip away cost layers fast enough to see profits in the short term. With that being the case, a bear call spread appears to be an advantageous strategy at this time. This strategy is designed to realize its full profit as long as the stock stays below the lower call strike price at expiration.

One trade which caught my eye was the August 11/13 Bear Call spread on CAL. You could pick up a 30 cent credit when the trade is opened, which works out to be a 17.6% return as long as CAL is below 11 at expiration in August. The stock could rise 17% without hurting the position.

These trades, as with all trades, are not without risk. Be certain you understand the risk/reward profile for any trade before you put your money at risk. Do your homework and try to have some fun out there.

if you have had any additional thoughts, ideas or great deals on airfares, please e-mail me at vwisemann@InvestorsObserver.com.