Are the Airlines a Value Play? Alcoa Suggest They Are

Parsing through Alcoa's (NYSE:AA) earnings call, several items caught my attention as being inconsistent with what we're seeing in the charts.  For longer term investors, the clues provided by AA suggest that the airlines industry may be a hidden value gem with serious growth potential over the next 18-months.  Take a quick look at the Airlines Industry Index weekly chart (XAL) and you'll see that, after a very nice run that started in early October, 2011, the entire industry entered a correction in January 2015 and that correction has been in progress ever since. 

XAL Weekly Chart

The industry did find support at its 200-period moving average.  That's especially significant because it is a long-term level that large institutions and mutual funds track.  They not only use it to determine if a long-term investment is in an uptrend (above its 200-period) or downtrend (below the 200-period) but they will also use that level to place automated buy or sell orders.  Remember, only the large players have sufficient capital to move the price, so when you see an industry like this bouncing off its 200-period average not once but three times, you can be sure that the major investment firms are buying at that level.

In their earnings call yesterday, Alcoa told us that large commercial aircraft deliveries were down in the first half of 2016.  While that sounds like a negative, it really isn't.  There's an oversupply in the market right now, with Airbus reporting that they have 36 wide-bodies sitting idle just waiting for engines.  This is also a transitional period within several of the major providers as airlines are adjusting their fleets between narrow and wide-body aircraft.  Read some of the trade press exchanges between Airbus and Boeing for more insight into that tug-of-war.

Alcoa also referenced a "careful ramp up of new models" and lower orders for legacy technology.  This is due to a shift within the industry to new jet engine technologies that experienced some significant technical problems in the first half of the year.  Those problems at this point have been overcome, however, and the forecast through 2017 is for double digit growth.

Most telling of all is a single line in the Alcoa slide presentation that accompanied their earnings call.  They said, "Airline profitability is at an all-time high."  Now, as a major supplier of product within that industry, Alcoa would be in a great position to know the inside scoop.  The charts for the airlines are all in correction mode, oil and fuel prices remain depressed, and the International Air Transportation Association (IATA) continues to report strong passenger demand into 2016.

This divergence between the stock trends and the underlying industry data suggest that the airline industry as a whole may be undervalued.  Delta Airlines (NYSE:DAL) reports earnings before the open this Thursday (July 14) and we will be closely monitoring their earnings call for confirmation of Alcoa's assessment.

The other major players that we'll want to watch are General Electric (NYSE:GE) reporting July 22nd, and Boeing (NYSE:BA) reporting July 27th.  GE is a major jet engine supplier and Boeing, obviously, is one of the major aircraft manufacturers.  Remember, it's not their earnings that we're interested in, per se, but rather their assessments of the overall industry. 

By the end of July, we should have a very good idea as to where the airline industry is headed in 2016 and the first half of 2017.  If Alcoa's assessment is accurate, however, it would appear the industry is number one on the runway and ready for takeoff.

Keeping an Eye on Southwest Airlines

Southwest Airlines (NYSE: LUV) reports earnings at 6:30 AM EST this Thursday.  The conditions are ripe for this low-budget airline to continue to their steady upward climb.  In their October announcement, they talked a bit about their entry into the international market, and with fuel costs driving downward and the strength of the US Dollar driving upward, there couldn't be a better time for them to branch out beyond our borders.

They plan to offer flights to Costa Rica starting in March, which is a perfect time weather-wise to vacation in that beautiful Central American tourist spot.  It will be interesting to see if there's any mention of ticket sales to that destination in Thursday's conference call.  International travel currently accounts for only 1% of Southwest's business, so the potential global upside is tremendous.  They describe their international plans for 2015 as "modest" and that suits me just fine.  Slow and steady, gaining reputation and market share, provides opportunity for long-term continuous growth.

Throughout the last quarter, Southwest continued to add destinations.  They added seven new non-stop destinations in October, and eight more in November.  As a reminder, they acquired a number of slots at Ronald Reagan National Airport (DCA) from American Airlines, and that has allowed them to add 44 new daily departures to seven new destinations. 

International flights from Houston won't be coming online until later in 2015, so you won't see that reflected in Thursdays numbers, but it's something to consider as you look at LUV's growth potential in the out-years.  The cities they are targeting, though, are impressive.  They already fly to Cancun, Mexico City, and Los Cabos from other cities in the US.  Add Puerto Vallarta and San Jose, Costa Rica and Belize City, Belize to the list for 2015, along with a major US tourist spot: Aruba.

Their expansion in Love Field, Dallas has been highly successful, where they added 16 new destinations.  Load capacity as of October was topping 90%, and as tourist travel increases in the US, demand for seats will be highly competitive.  What makes Southwest even more attractive in this regard is that, in addition to very competitive ticket prices, they still permit travelers to carry two bags free on international flights.  That's a sure-fire market share winner on competitive routes, although it will be interesting to see where they pick up that revenue stream that other airlines are currently grabbing.

Read more here: http://www.star-telegram.com/news/business/aviation/sky-talk-blog/article4427670.html#storylink=cpy

Thursday's earnings announcement will be interesting.  I believe Southwest has excellent growth potential, especially with their low-cost international travel, but some strong numbers and strong forward guidance will be necessary this week for Southwest to overcome their currently high valuation compared to earnings.  In the meantime, stay tuned to Delta Airlines' earnings announcement tomorrow for some clues as to where this industry is headed in 2015.