Is U.S. Airways the Next Kmart?

Well, judging from the stock price action lately, you can see some correlation. Kmart stock began a rapid ascent after emerging from Chapter 11 bankrupcty (it has risen 700% in fact). Similarly, U.S. Airways (LCC) recently completed a merger with America West and new equity began trading in late September at around $20 per share.

Here we are only six weeks later and the stock is breaking through $30, for a move of 50 percent. Is this the start of a bigger move a la Kmart? Let’s not get ahead of ourselves. It is true that the airline’s cost structure has been greatly improved and debt has been wiped away by the courts, but we are still talking about an airline here, with oil at $60 a barrel.

With other airlines also emerging from bankruptcy court, LCC is not alone is having a new, leaner, and meaner business. However, these companies still can’t make money with energy prices this high, and the competition will hardly let up with carriers able to revamp and go at it all over again.

Monitoring future financial results out of LCC (they just reported Q3 today) may prove a valuable use investors’ time, as it’s quite possible the new U.S. Airways will turn out to be nothing like the new Kmart.

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6 Thoughts on “Is U.S. Airways the Next Kmart?

  1. Jack Miller on November 9, 2005 at 11:21 AM said:

    AMR and CAL are up as well. The reality is that business travel is booming. Business international travel in particular. AMR, CAL and even the bankrupted DAL and NWAC are increasing international capacity at the expense of domestic capacity. Coach seats are being reduced while much more profitable business and first class seats are being increased.

    LCC is doing well. There is a real possibility that AMR wil earn $8.50 or more in 2007 or 2008. Sixty dollar oil is not going to stay around forever. Did you read in the WSJ that China burned diesel fuel to produce electricity until recently? Now the China demand has slowed dramatically. $40 oil is on its way. I can’t give you a precise date but no later than 2008 when a number of international projects are complete.

    Notice the transportation index has broken out. Don’t take me wrong, I admit that this winter heating fuel is going to be dear and next summer gas is still going to be in tight supply. I suspect $55 oil will be a pivot point for a while. However, with billions of labor and other costs cut out by AMR, CAL and LCC, these firms will make a profit at $55 and then a huge profit at $50.

    A $1 reduction in the price per barrel increases the airlines bottom line by $161 million dollars! Changing 3 coach seats for 2 first class seats can increase annual revenunes by thousands of dollars while lowering costs!

  2. Chad Brand on November 9, 2005 at 11:35 AM said:

    I agree that if oil prices plummet, the airlines will make money and the stocks will be okay. However, I don’t think AMR earns $8 per share with oil at $40 per barrel.

    It all depends on where you see oil going. If we get back to $30-$40 per barrel in the next year or two, shorting these stocks will not work.

    However, I do not think we’ll see oil in the 30’s. Also, business travel is doing well, but an economic slowdown will put that in jeopardy as companies become even more wary of costs. Competition would also reduce fares, not increase them.

    Suggestions that AMR, CAL, and LCC will make a huge profit at $50 and $55 oil I think won’t prove true, given the competitive pressures that will arise from all of these “revamped” carriers. Few people are expecting oil prices to rise next year, but none of the major airlines (LCC, NWA, DAL, AMR, CAL) are expected to be profitable for 2006.

    The only way we’ll get that is a drop in oil into the 40’s, which I don’t see. As always, we’ll just have to wait and see.

  3. Jack Miller on November 10, 2005 at 12:09 AM said:

    Not to quibble but the consensus estimate is for CAL to earn 17 cents per share in 2006; S&P has 18 and 19 dollar price targets on CAL and AMR.

    As you suggest, these forecast are made on the premise of flat oil prices. I agree that oil is not likely to plummet to $40 anytime soon. However, the trend in oil is down and the trend in international business travel is up by wide margins. No one knows, how deep NWA and DAL will have to cut capacity before emerging from bankruptcy.

    The real point that I believe we are both making is that we will probably never again see an industry leveraged to this extent again. This extremely high operating and financial leverage cuts both ways; it can result in bankruptcy or in huge profits. Some carriers will have to cut back sharply to stay alive but when demand exceeds current suppy the leverage factor can boost revenues like no other industry.

    Yes, although AMR will struggle to break even next year at $60 oil, I believe we will see $50 by the end of the year and thus a decent profit in 2006 (which will not be the first time the consensus was wrong). With the huge leverage involved, $8 or more is doable by 2008.

    By the way, I read your post daily. Keep up the excellent work.

  4. Chad Brand on November 10, 2005 at 6:14 AM said:

    Indeed, it looks like CAL estimates for 2006 are changing daily as numbers are revised. Just a week ago we were at a $1 per share loss. Of course, I doubt analysts can forecast what they’ll make anyway.

    My main two points are that I think oil will remain high for years to come, and a weakening economy in 2006 will do more damage to overall airline traffic and average fares than it will to help it.

    You are right that deep supply cuts would help pricing, but the industry has needed to do that for a long time and really hasn’t aggressively done so as of yet.

  5. Jack Miller on November 10, 2005 at 10:09 AM said:

    LCC 2006 guidance is for $.64 (if memory serves). Oil prices follow the hog market spider web pattern (discovered about 100 years ago). This means that oil prices overshoot equilibrium on the way up and overshoot equilibrium on the way down. Abundant supplies of fuel are available at $40 per barrel. It will take at most, three years for these abundant supplies to hit the market. Furthermore, after rapid demand growth in China for five years, demand has been reduced this year. India and other contries are experiencing the same phenomena. Demand growth will resume but not at the pace of past years.

    The economic slow down you are refering to will be a slow down in the purchase of big ticket items by consumers. Consumers can no longer tap equity from their home to buy SUV’s, boats, et. al. However, small business sentiment is the opposite of consumer sentiment. Small businesses are expanding. Business travel is extremely strong. There should be, if any, only a mild business sector slow-down in 2006. Before long the FOMC is going to have to stop hitting the brakes.

    Can you believe how hard the DAL pilots are still fighting managment? Same for the NWAC unions. These guys are going to eventually come out of bankruptcy but as much smaller carriers. AMR and CAL will pick up much of the business traffic. The discounters simply cannot offer the world wide business traveler the same services.

    Have you noticed the expansion of the business travel clubs? Jet Blue or Southwest do not offer these but AMR is making hay off of services from hot showers to hot internet spots.

  6. Chad Brand on November 10, 2005 at 10:22 AM said:

    The bottom line is oil prices will still determine if these newly restructured carriers will survive. I am suspect of claims that India and China growth will slow, and abundant supplies will hit the market, given that nobody knows yet where these supplies will come from. Of course, I am a commodity bull and think the current bull run will last through this decade.

    As for an econmoic slowdown ebing only consumer-oriented, don’t forget how that would trickle down to the corporate sector. Less demand for consumer goods (Two-thirds of the economy) will reduce profit margins for corporations that sell to consumers. Margins are very cyclical and currently are at record-high levels.

    When margins come down, companies will need to lay off workers and cut other costs to hit their earnings targets. That leaves fewer business travelers, and companies that are more likely to have a cofnerence call than jump on a place. We saw that during the last recession only a few short years ago.

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