Sector’s seven-month run leaves fewer offering investment upside
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By Christopher Hinton, MarketWatch
NEW YORK (MarketWatch) — Airline shares have had a great run since the end of last summer as the shadow of bankruptcy subsided and plunging demand trends leveled off, but there are still some gains to be had for discriminating stock pickers, analysts say.

“With the overall markets in a very overbought phase, I would be very reluctant to buy most airline stocks at this moment in time,” said Robert Herbst, founder of Airlinefinancials.com, a consultancy.

However, analysts reached for this article agreed that a trio of carriers — Delta Air Lines (DAL 14.62, -0.03, -0.20%) , Continental Airlines (CAL 22.13, +0.05, +0.24%) and Alaska Air Holdings (ALK 41.12, -0.02, -0.05%) — have the potential for solid long-term growth that could fuel a move higher in their stock prices from current levels.

“Though their stock prices have come back strong, they will benefit the most from worldwide economic growth and solid balance sheets,” said Ray Neidl, an independent airline analyst in New York.

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The airline sector got hammered at this time last year, hit by the one-two punch of the credit crisis and declining demand, raising fears of insolvency among investors.

Indeed, the benchmark NYSE Arca Airline Index (XAL 37.40, -0.34, -0.89%) lost half its value from December 2008 through March 2009 as many shareholders panicked and cashed out.

But by August the worst appeared to have passed. Banks and financial firms reopened the credit tap and airlines refinanced debt and raked in billions in new loans, putting themselves on a firmer financial footing.

And on the business side, air operators righted themselves through rollbacks in seat capacity and prepared for a potential recovery this year.

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In the last seven months, the Arca Airlines Index has since gained 78%, reaching three-year highs in the last month as airlines reported demand growth and higher average ticket prices.

Earlier this month, the International Air Transport Association halved its projected 2010 global loss for the industry to $2.8 billion from $5.6 billion, citing better-than-expected recovery in demand.

Better business backdrop

“Air fares are firming up, there is no question,” said George Hobica, founder of New York-based Airfarewatchdog.com. “This is the first winter in 10 years there wasn’t a $250 or $300, tax-included deal to somewhere in Europe.

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“Usually by February, the airlines start to get panicky, so they have succeeded in capacity cuts and they don’t have to have those fire sales.”

Indeed, increases in international fares are outpacing the domestic recovery as the growth in global trade encourages more premium-class business travel — a huge benefit to the so-called network carriers, airlines that are more exposed to international business travel.

oday’s stock prices aren’t saying they are going to see happy days yet,” cautioned Neidl. “But going forward, if the economy strengthens further, then over the next year or two today’s stock prices are going to look cheap.”

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A riskier move, therefore, might be US Airways Group (LCC 7.21, -0.01, -0.14%) , according to Neidl. The company has good management but suffers from a disadvantageous cash position as well as poor market share. If the economy bounces back at a faster rate, the stock should exceed the performance of its peers.

Valuation plays

On a valuation basis, US Airways shares trade at about three times the 2012 Wall Street earnings consensus of $2.36 a share, as provided by FactSet Research. By comparison, shares of the top seven U.S. airlines trade at a price-earnings ratio of about six times their average profit estimate.

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A lower P/E multiple suggests a stock could be undervalued, but it could also reflect greater investment risk.

Delta and Continental, favorites among analysts, trade at multiples of about 7.4 and 5.4 times their projected 2012 profit, respectively.

Neidl adds that Copa Holdings SA (CPA 59.93, +1.41, +2.41%) , the Panamanian operator of Copa Airlines and Columbian carrier AeroRepublica, is a safer bet because of the growing Latin American economy and rising demand for international travel.

For Herbst at Airlinefinancials.com, his money is on Alaska Air, the Seattle-based owner of Alaska and Horizon airlines, as well as Allegiant Travel (ALGT 58.25, +0.36, +0.62%) .

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“Allegiant is my No. 1 choice for having long-term growth and the strongest balance sheet,” said Herbst, who frequently trades airline stocks and derivatives, though he currently doesn’t hold a position.

“Alaska has a very solid balance sheet … and recently settled their pilots’ contract,” Herbst said. “Alaska also has a growing route structure that has relatively little low-cost competition.”

Shares of Alaska Air trade at about 6.5 times its 2012 profit outlook of $6.37 a share, and the stock has more than doubled in value over the past year.

Allegiant shares, up 33% in the last year, trade at about 9.8 times the carrier’s profit estimate for 2012.

Christopher Hinton is a reporter for MarketWatch based in New York.

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