By Sam Stovall Given all the negative news surrounding the airline sector -- including the Sept. 14 bankruptcy filings of major carriers Delta and Northwest -- it may come as a surprise that stocks in the group have exhibited some recent strength. That's borne out by the improvement in the S&P 1500 Airlines subindustry index's rolling 12-month relative strength ranking in the past four weeks. This index consists of seven large-, mid- and small-cap companies.
The rolling 12-month relative strength price chart (pictured below) demonstrates the subindex' recent outperformance. As a reminder, the jagged blue line represents the subindex' rolling 52-week price performance as compared with the 52-week performance for the S&P 1500. Any point above 100 indicates market outperformance over the prior year, while points below 100 indicate market underperformance. The red line is a rolling 39-week moving average, while the two green bands indicate one standard deviation above and below the subindustry index' 14-year mean relative strength.
During 2004, this subindustry index underperformed the broader market, falling 6.8%, while the S&P 1500 advanced 10%. Even though the group is off nearly 13% year-to-date through Sept. 23, this subindustry index gained 3.6% in the past 13 weeks, while the overall market rose 2.3%.
TERROR'S LIMITED IMPACT. The question remains if this group's price recovery is only a short-term trading opportunity. So I reviewed this group's investment outlook with Standard & Poor's equity analyst Jim Corridore.
S&P's fundamental outlook for airline stocks is neutral, says Corridore. He believes high oil prices and low airfares are likely to lead to another large loss for the industry in 2005. Recent fare hikes over the past quarter have started to help airline yields -- a measure of unit revenues -- and this, coupled with a growing number of passengers flying, has started to help on the revenue line.
However, this positive impact has still been more than offset by rising oil prices, which have continually hit new record highs in recent weeks. S&P does not expect the July 7 bombings in London to have a major impact on air-travel demand so long as that remains an isolated incident. Demand for international air travel has been quite robust, and Corridore expects this to continue.
S&P estimates that the top 10 carriers lost about $10 billion in 2004, with another large loss expected for 2005. Corridore expects labor cost cuts at many of the major carriers and increased passenger traffic to aid results in 2005, but high oil prices and low airfares should keep the overall industry unprofitable, in his view.
BREAK IN THE CLOUDS. Airfares have remained weak due to aggressive price competition in the transcontinental and other markets, amid aggressive sales and a $499 maximum one-way transcontinental fare cap by Delta.
However, in the past quarter, major airlines have pushed through several fare hikes, most of which have stuck -- a situation that hasn't occurred since before the September 11 terror attacks. In addition, in July, Delta raised its one-way cap by $100, to $599. While Corridore doesn't think this is enough to offset oil prices of around $60 per barrel, he says it's a positive sign that hasn't seen for quite some time.
Revenue passenger miles (RPMs) -- an industry metric representing one passenger transported one mile in revenue service -- rose 10% in 2004, to 655 billion, from 595 billion in 2003. The 2004 statistic is just shy of the level attained in 2000, the last year of relative airline industry health, though yields are down sharply over that same period. Corridore expects about a further 10% rise in passenger traffic in 2005.
TWO HIGH FLIERS. Of the 10 largest U.S. carriers, 5 are in bankruptcy, due to the recent filings by Delta and Northwest. At the same time, low-cost carriers have been growing rapidly and profitably, a trend that we expect to continue.
So there you have it. In S&P's view, the subindustry's momentum looks favorable, but the fundamentals don't support an aggressive stance in the coming year. Among the the major airline stocks he covers, Corridore's top selections are AMR (AMR), SkyWest (SKYW), and Southwest Airlines (LUV), each ranked 4 STARS (buy).
Source: Standard & Poor's
Industry Momentum List Update
For regular readers of the Sector Watch column, here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500) as of September 23, 2005.
Construction & Engineering
Diversified Metals & Mining
Fertilizers & Agricultural Chemicals
Health Care Services
Managed Health Care
Oil & Gas Drilling
Oil & Gas Exploration & Production
Oil & Gas Refining & Marketing
S&P STARS: Since January 1, 1987, Standard & Poor's Equity Research Services has ranked a universe of common stocks based on a given stock's potential for future performance. Under proprietary STARS (STock Appreciation Ranking System), S&P equity analysts rank stocks according to their individual forecast of a stock's future capital appreciation potential versus the expected performance of a relevant benchmark (e.g., a regional index (S&P Asia 50 Index, S&P Europe 350 Index or S&P 500 Index), based on a 12-month time horizon. STARS was designed to meet the needs of investors looking to put their investment decisions in perspective.
S&P Earnings & Dividend Rank (also known as S&P Quality Rank): Growth and stability of earnings and dividends are deemed key elements in establishing S&P's earnings and dividend rankings for common stocks, which are designed to capsulize the nature of this record in a single symbol. It should be noted, however, that the process also takes into consideration certain adjustments and modifications deemed desirable in establishing such rankings. The final score for each stock is measured against a scoring matrix determined by analysis of the scores of a large and representative sample of stocks. The range of scores in the array of this sample has been aligned with the following ladder of rankings:
S&P Issuer Credit Rating: A Standard & Poor's Issuer Credit Rating is a current opinion of an obligor's overall financial capacity (its creditworthiness) to pay its financial obligations. This opinion focuses on the obligor's capacity and willingness to meet its financial commitments as they come due. It does not apply to any specific financial obligation, as it does not take into account the nature of and provisions of the obligation, its standing in bankruptcy or liquidation, statutory preferences, or the legality and enforceability of the obligation. In addition, it does not take into account the creditworthiness of the guarantors, insurers, or other forms of credit enhancement on the obligation. The Issuer Credit Rating is not a recommendation to purchase, sell, or hold a financial obligation issued by an obligor, as it does not comment on market price or suitability for a particular investor. Issuer Credit Ratings are based on current information furnished by obligors or obtained by Standard & Poor's from other sources it considers reliable. Standard & Poor's does not perform an audit in connection with any Issuer Credit Rating and may, on occasion, rely on unaudited financial information. Issuer Credit Ratings may be changed, suspended, or withdrawn as a result of changes in, or unavailability of, such information, or based on other circumstances.
S&P Core Earnings: Standard & Poor's Core Earnings is a uniform methodology for calculating operating earnings, and focuses on a company's after-tax earnings generated from its principal businesses. Included in the Standard & Poor's definition are employee stock option grant expenses, pension costs, restructuring charges from ongoing operations, write-downs of depreciable or amortizable operating assets, purchased research and development, M&A related expenses and unrealized gains/losses from hedging activities. Excluded from the definition are pension gains, impairment of goodwill charges, gains or losses from asset sales, reversal of prior-year charges and provision from litigation or insurance settlements.
S&P 12 Month Target Price: The S&P equity analyst's projection of the market price a given security will command 12 months hence, based on a combination of intrinsic, relative, and private market valuation metrics.
Standard & Poor's Equity Research Services: Standard & Poor's Equity Research Services U.S. includes Standard & Poor's Investment Advisory Services LLC; Standard & Poor's Equity Research Services Europe includes Standard & Poor's LLC- London and Standard & Poor's AB (Sweden); Standard & Poor's Equity Research Services Asia includes Standard & Poor's LLC's offices in Hong Kong, Singapore and Tokyo.
In the U.S.
As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services U.S. have recommended 30.2% of issuers with buy recommendations, 57.5% with hold recommendations and 12.3% with sell recommendations.
As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services Europe have recommended 34.4% of issuers with buy recommendations, 46.8% with hold recommendations and 18.8% with sell recommendations.
As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services Asia have recommended 33.3% of issuers with buy recommendations, 47.2% with hold recommendations and 19.5% with sell recommendations.
As of June 30, 2005, research analysts at Standard & Poor's Equity Research Services globally have recommended 31.0% of issuers with buy recommendations, 55.4% with hold recommendations and 13.6% with sell recommendations.
5-STARS (Strong Buy): Total return is expected to outperform the total return of a relevant benchmark, by a wide margin over the coming 12 months, with shares rising in price on an absolute basis.
4-STARS (Buy): Total return is expected to outperform the total return of a relevant benchmark over the coming 12 months, with shares rising in price on an absolute basis.
3-STARS (Hold): Total return is expected to closely approximate the total return of a relevant benchmark over the coming 12 months, with shares generally rising in price on an absolute basis.
2-STARS (Sell): Total return is expected to underperform the total return of a relevant benchmark over the coming 12 months, and the share price is not anticipated to show a gain.
1-STARS (Strong Sell): Total return is expected to underperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares falling in price on an absolute basis.
Relevant benchmarks: in the U.S. the relevant benchmark is the S&P 500 Index, in Europe the S&P Europe 350 Index and in Asia the S&P Asia 50 Index.
For All Regions:
All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this research report.
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Stovall is chief investment strategist for Standard & Poor's