Falling Oil Prices Cut Operating Costs : Merger Wave Turns Airline Stocks Into High Fliers
As airlines have been gobbling each other up, their stocks have been high fliers, constituting one of the best performing groups in Wall Street’s current bull market.
According to Mike Derchin, airline analyst for First Boston Corp., a brokerage house here, airline issues rose 18.9% in the first eight weeks of 1986, compared to a 5.2% rise in the Standard & Poor’s index of 500 stocks during the same period.
Airline stocks actually began doing extremely well at the start of 1985 and for the first nine months of the year were very strong. Then, as the result of traffic weakness, safety concerns resulting from an unusual number of fatal accidents and the firming up of fuel prices, they took a temporary tumble.
Up 10% to 20% in Month
But, “in the last four or five weeks, airlines have returned to favor,” said Timothy Pettee, airline analyst with L. F. Rothschild, Unterberg, Towbin, a New York investment house. “The moves in the stocks have been sharp and extremely profitable for investors. Almost across the board, the airline stocks are up 10% to 20%.”
According to Aviation Daily, an industry newsletter, 52-week highs were set by seven carriers last week. They included Western Airlines, which has been the subject of much merger speculation. Of the 29 airlines on the New York and American stock exchanges tracked by Aviation Daily, 17 advanced, 11 retreated and one was unchanged.
While there are several reasons for the surge, analysts say the major one is the “speculative fever” resulting from a number of major airline consolidations recently: Northwest Airlines announced its intentions to take over Republic Airlines; Texas Air and Eastern agreed to merge; Trans World Airlines said it would take over Ozark Airlines, and People Express took over Frontier Airlines, Britt Airways and bankrupt Provincetown-Boston Airlines.
Many investors believe the trend has just begun, and lots of Wall Street money is being bet on who might be next to make a deal.
Barry J. Gordon, president of American Fund Advisors, which runs a mutual fund--National Aviation & Technology Corp.--that invests in airlines, aerospace and high-technology stocks, said that, so far this year, the fund has outperformed the Standard and Poor’s 500 by between 35% and 40% and would have done even better if the fund were composed only of airline stocks.
Gordon said he has done well investing both in takeover candidates and in airlines that have done the acquiring. His fund had large positions in Ozark, Republic and Northwest. Now he is still heavily invested in some of the airlines that, according to speculation, are merger candidates. They include Pacific Southwest Airlines (PSA), Western Airlines, Alaska Airlines and Aloha Airlines.
The airline index, launched by the American Stock Exchange late last year to follow the performance of the industry through stock movement in five widely held and actively traded airlines, has risen 15.6% since the first of the year--from 106.13 to a high late last month of 122.69. (It did dip to 119.13 this week.)
The index’s component companies are AMR Corp. (parent of American Airlines), Delta, Northwest, UAL Inc. (holding company for United Airlines) and USAir Group.
But not all of the upward trend in the airline stocks is the result of merger activity.
Another reason for the bullishness in the airline stocks is the continuing dramatic drop in oil prices. Falling crude oil prices could result in U.S. airlines saving $1 billion or more in fuel costs in 1986. They saved $600 million in each of the last two years as oil prices fell more slowly than they have in recent weeks.
$3 Billion in Savings
According to George James, president of Airline Economics, every $1 drop in the barrel price of oil results in a saving of 2.5 cents a gallon on the price of jet fuel. The U.S. industry uses about 12 billion gallons of fuel a year, so a $10 drop in the price per barrel would result in savings of $3 billion if all of the reduction is passed on to the ultimate consumer. The price drop, however is seldom passed on completely.
According to various sources, the airlines are paying between 60 cents and 67 cents for fuel to be delivered in May and June. They are paying about 82 cents a gallon for the fuel being delivered now.
Edward I. Colodny, chairman and president of USAir, said every penny his airline saves per gallon in jet fuel translates into a saving of $4 million in operating expenses annually.
There is a question, too, as to how much of the money saved the airlines will be able to keep. Discount pricing in the industry might force them to pass much of the savings on to the consumer. And there are other reasons for the rise in airline stocks.
With no recession expected, airlines are expecting a decent rise in passenger revenue. First Boston’s Derchin projects that system traffic growth will be between 9% and 10% this year while there will be only a 2% decline in yields (revenue per passenger-mile).
While the market for airline stocks has been buoyant, some investors do have concerns, observers say. These include fear of fare wars, fear that consumers might travel less this year (domestically because they are spent out and internationally because of terrorism and the drop in the value of the dollar), fear that oil prices might not decline as much as expected, doubts that the airline merger trend will continue, excess capacity, discounts for corporate customers and reversal of labor cost progress.
Analyst Paul Karos of the Minneapolis brokerage of Piper, Jaffray & Hopwood feels that questions about passenger fares and the price of fuel “make things about 1986 very difficult to forecast.”
He added: “If you look at most analysts’ estimates, they are not extremely bullish. . . . There are no leaps and bounds expected in growth and earnings. We are not telling a big bull story. But we are not out there telling a big bear story either.”
How Major Airlines Have Fared
Closing Price Closing Price % Dec. 9,1985* March 6, 1986 change AMR Corp. (American) $42.375 $49.25 +16.2 Continental 13.00 14.75 +13.5 Delta 39.85 42.00 +5.7 Eastern 6.75 8.75 +29.7 NWA Inc. (Northwest) 50.50 48.50 -4.0 Pan American 7.875 9.00 +14.3 People Express 8.625 10.125 +16.7 Piedmont 33.625 40.125 +19.2 Republic 10.00 15.625 +56.8 Trans World 19.00 16.625 -12.2 UAL Inc. (United) 51.25 55.375 +8.0 USAir Group (USAir) 30.50 36.75 +20.5 Western 7.25 11.875 +63.7 * Date of OPEC meeting that triggered recent oil price drop.
The Amex airline index measures changes in the stock price of five corporations: AMR, Delta, Northwest, UAL and USAir.
