Finding Value In Travel Stocks: LUV, AAI, UAUA, DAL, JBLU

Since companies that operate in the travel industry are some of the most economically sensitive, it comes as no surprise that many stocks in this space have underperformed. Perhaps more than any other business, these companies are tied to the labor market. With the unemployment figure hovering around the 9.5% mark for the past several months, and with new, weekly unemployment claims stubbornly remaining around 450,000, it’s safe to say that the job market has not shown signs of a meaningful recover yet. This would help explain why a name like AMR (NYSE: CORP) – American Airlines parent company – is down 16% so far this year compared to a 3% gain for the S&P 500. That level of underperformance raises a question, and that is: “Is the bad news already priced in, and are AMR and other travel-related stocks cheap?” On a technical basis, AMR certainly looks to have found a bottom, as our trading report (available to all subscribers) suggests, but do the fundamentals support that thesis?

Airline Forward P/Es Look Miniscule
Recently, a considerable amount of noise has been made about the “value of valuations.” The argument essentially states that P/E ratios are becoming less important because stock trading is increasingly being run by machines and black boxes. There may be some element of truth to this debate, but machines cannot (at least not yet) replicate human emotion. Whether a stock, or anything else for that matter, is perceived as cheap or expensive plays into psychology, and therefore still matters a great deal in analysis. With that said, it seems investors and traders are largely ignoring the dirt cheap valuations on many airline stocks. For instance, the aforementioned AMR has a very low 1-year forward P/E of 9.4x expected FY11 earnings, while UAL Corp (Nasdaq: UAUA) currently trades with a dirt-cheap 1-year forward P/E of 4.5x. The smaller, regional airlines are priced a bit higher, but not expensively by any means. Southwest Airlines (NYSE: LUV) - which apparently saw good value in AirTran Holdings (AAI), acquiring it for $7.69 per share – still has a very reasonable forward P/E of 12.7x.

An Airline Value Trap?
Rarely is buying a stock solely due to valuation a good idea. The other side of the coin to a stock’s low valuation is that “there is a reason it is cheap.” In other words, there should be some other catalyst that investors or traders can point to, in order to justify a long position. For airlines, one such possibility is a continuation of consolidation in the space. Over the past two months, we have seen heavy M&A activity in the tech sector, with Hewlett Packard (NYSE: HPQ) buying 3Par (NYSE: PAR) and IBM (NYSE: IBM) acquiring Netezza (NYSE: NZ), for example. Overlapping businesses, low stock prices, quick ROIs, and companies flush with cash were the primary drivers for the sudden rush of deals. Interestingly, many of the same attributes are now in place in the airline sector, which could lead to more deals and higher stock prices. It wouldn’t be surprising to see another major carrier goggle up a smaller, well-run operator, like JetBlue (NYSE: JBLU).

Flying High In 2011

Another intriguing aspect to this group is that their financial results are expected to be vastly improved over last year. On September 21, The International Air Transport Association revised its 2010 industry outlook, projecting a total profit of $8.9 billion versus its prior expectation of $2.5 billion in June. The association stated, “The industry recovery has been stronger and faster than anyone had expected.” Enthusiasm should be tempered, though, because it also states that operating margins are still razor thin and there are lingering doubts about how long the upturn will last. But, the improving fundamentals shouldn’t be ignored, and are evident in the Street’s earnings projections for individual companies. Delta Airlines (NYSE: DAL) is expected to see earnings grow by 47% in 2011 – a rate that is more akin to a high-tech company, than an airline. That stock, as well as many of the other airline stocks mentioned today, have traded sideways for quite some time but may be ready to move higher. Subscribers to Stock Traders Daily can easily uncover what key levels will be in play ahead by accessing our trading reports on these names.

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