Looking to buy something that will keep on giving? Consider
airline stocks. They have been doing incredibly well lately, but they aren't
even close to achieving maximum altitude. At least that's what Morgan
Stanley says about the airline industry, which has doubled the broader
market by surging a whopping 115% since the start of 2013.
The rapid ascent has been fueled by a major transformation
in the industry that's reshaped the competitive landscape and boosted
profitability. So did investors completely miss the flight on these red hot
stocks?
Cheap valuations: Of
course, there's no guarantee Morgan Stanley is right. A geopolitical event or
an oil price shock could ground these stocks. However, this group does look
cheap based on their projected profits. Despite their meteoric rise, airline
stocks trade at just 10 times forward earnings, compared with a multiple of 17
for the broader market.
That disparity shows how the industry is having a hard time
shedding its image as a nightmare for investors, even legendary ones like
Warren Buffett.
The Oracle of Omaha once blamed a bet on US Airways on
"temporary insanity" and today he avoids airline stocks like former
NFL coach John Madden avoids actual airlines.
Not your father's
airline industry: Airlines got such a bad reputation because financial
stress left many of them in bankruptcy court. But in recent years they've made
huge strides in fixing their problems, especially slashing leverage and cutting
benefit obligations.
The industry has also gone through a ton of consolidation.
Legacy airlines have teamed up through mergers and joint ventures. Even
low-cost carriers are consolidating. Those structural changes make it much more
difficult for new entrants to break into the industry.
Remembering mistakes from the past, airlines have also been
very conservative with adding capacity in the form of new planes with lots of
seats. In other words, supply has gotten out of whack with demand. That's good
news for airlines' bottom lines.
Profits poised to
soar: Out of all 60 industries in the stock market, airlines sport the
third-highest long-term growth rate at 20.8%. That puts them somewhat below
fast-growing Internet companies, but above other darlings of the stock market
like health-care technology and biotechnology.
Consumers won't like to hear this but Morgan Stanley thinks
airlines can further juice their profits by jacking up fares, which have been on
the rise despite lower costs.
The bank argues air travel is "cheap" today by
historical standards and the economy can absorb more airline real price growth.
The bank's quantitative analysis gave the highest marks to Delta Air Lines and JetBlue
Airways, each of which have flown 60% higher this year.
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