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Bulls On The Runway Start To Bellow



In Wall Street's lingo, airline stocks are "early cyclicals"--they're bought at the start of an economic expansion. That's because once business picks up, so do air travel, profits, and ultimately, the prices of airline stocks. Yet though the expansion is 40 months old, the stocks are still on the ground, hobbled by overcapacity, high costs, fare wars, and of course, red ink. Most of the large U.S. carriers' shares sell for less today than they did in early 1991.

But at long last, many analysts and portfolio managers believe that the stocks will soon take off. That's because the airlines are starting to cut deals with their labor unions to lower compensation and

to raise productivity. They're also scrapping unprofitable routes and trimming their fleets. And though the fare wars are by no means gone, they're more restrained than just a few years ago. "It's a classic turnaround," says Sharon Fay, a senior research analyst at Sanford C. Bernstein & Co. "Demand is growing as supply is shrinking and costs are coming down."

SLOW STARTERS. Even more important, there's mounting bottom-line evidence of the turnaround. In recent weeks, both UAL Corp., parent of United Airlines, and AMR Corp., parent of American Airlines, the two largest U.S. carriers, surprised Wall Street by posting strong second-quarter earnings. So did Northwest Airlines Inc., the No.4 carrier, which went public last year to unravel the 1989 leveraged buyout that nearly bankrupted the company. Even industry laggard USAir Inc. showed an 18% gain in operating profits. Says analyst Michael W. Derchin of NatWest Securities Corp.: "The second quarter should be the airlines' best in five years, and the third one looks pretty strong as well."

For all the good news, the stocks aren't moving up quite yet. "One good quarter isn't enough," says Thomas M. Keresey, president of Palm Beach Investment Advisers Inc., who, like many institutional investors, remains skeptical of the airlines. The only flier to take off was UAL, which on July 12 voted to put 55% of its stock into an employee stock ownership plan in exchange for a 14% wage-and-benefit cut. Since then, shares have climbed 14%.

United's labor accord sets a pattern the others will have to follow, especially to compete against lower-cost operations such as Southwest Airlines and startups such as ValuJet and Kiwi International. American, Delta, and USAir are seeking new labor contracts, and the betting is they'll get them. "Either labor negotiates now or negotiates when the airline is at death's door," says analyst Rose Ann Tortora of Donaldson, Lufkin & Jenrette Securities Corp.

There'll be no enduring airline revival unless management gets labor's help. Wages and benefits amount to some 30% of airline operating expenses, vs. 10% each for maintenance, landing rights, and travel-agent commissions, according to analyst Tim Pettee of Alliance Capital Management. The airlines don't have any control over fuel--15% of operating expenses--and that always makes the stocks somewhat risky.

But the airlines' advocates say the risk is worth taking: The stocks have underperformed the market for so long that once the turnaround story catches on, the stocks will soar. Indeed, the airlines are so reviled that they are conspicuously absent from most institutional portfolios.

Much of the ownership is concentrated in a handful of bottom-fishers. Alliance Capital owned as much as 17% of UAL before the ESOP--a figure now cut in half--and owns 7% each of Southwest and USAir. Bernstein holds 8% of Delta Air Lines Inc. Capital Research & Management Co. controls 5.5% of AMR. These shareholders are not likely to bolt soon. Bernstein's Fay says the firm is only at the breakeven point on its airline investments and is expecting a "pronounced recovery" in the stocks.

BIG MOVES. Airline watchers are generally recommending the Big Three: UAL, AMR, and Delta. Looking toward 1995, they're forecasting a 56% gain for AMR and a snazzy 72% for UAL. Some are saying nice things about Northwest, and most are still waiting for USAir and Continental to turn profitable. Ironically, Southwest, the one airline to make money for investors in the 1990s--up 200% over the past three years--is now losing some of its allure. The reason: The low-cost, short-haul carrier is losing its uniqueness as it moves into larger markets and is challenged by the majors. The analysts still like Southwest, but they believe that the Big Three will fly higher.

Even diehard airline bulls go into these stocks with an idea of selling when earnings start to sputter. But before that happens, investors can make a bundle. "Airlines have two really great years every decade," says Lehman Brothers Inc.'s Helane Becker. "And we've just started one of them."Airline Profits Are Gaining Altitude

Stock Price 52-week Earnings per share

High Low Last 12 mos. 1994(est.) 1995(est.)

AMR 57 3/4 72 3/4 52 1/8 $-0.57 $4.05 $6.31

CONTINENTAL 15 3/8 30 1/8 11 1/4 -4.47* -4.61 2.31

DELTA 47 1/2 61 1/8 39 1/2 -5.22* 3.91** 5.73***

NORTHWEST 17 3/8 18 11 1/2 0.09 1.54 2.94

SOUTHWEST 27 39 24 1/8 1.27 1.48 1.88

UAL 99 105 1/8 77 3/4 2.41 5.49 9.43

USAIR 6 7/8 17 1/2 6 1/8 -9.35 -8.05 -1.53

*Last 12 months through March, 1994 **Fiscal year ending June, 1995 ***Fiscal year ending June, 1996




Jeffrey M. Laderman in New York

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