More signs of strong pricing discipline in the airline sector make the legacy stocks look worth pursuing. After well-documented decades of losses, the airlines appear more inclined to focus on profits than on passenger growth.
Recently, both Orbitz (NYSE: OWW ) and Travelocity announced that Thanksgiving airfares were expected to be 7%-9% higher than fares from last year. This trend might not be welcome news to the people planning to fly over the holiday period, but it should be very encouraging news to airlines. Yet, online travel sites such as Orbitz might struggle if the higher fares push some travelers to seek alternative transportation.
While higher fares might lead to lower transactions for online travel sites, it should lead to higher profits for legacy airlines such as Delta Air Lines (NYSE: DAL ) , United Airlines (NYSE: UAL ) and US Airways (NYSE: LCC ) . These legacy airlines should continue to profit from lower pricing competition and higher levels of discipline in the industry.
Orbitz expects price hikes greater than 9%
The Orbitz study shows that this year the average airfare price is up nearly 10% for the 10 top Thanksgiving destinations. Of those 10 top destination cities, every location is up around 11% except for Los Angeles and San Francisco. Phoenix ties for the second-largest increase, with a 13% hike, which should benefit US Airways significantly considering that the city is its headquarters and major hub. Delta likely should continue to benefit due to already being the most profitable airline.
Orbitz has soared 250% in the last year, yet capacity constraints and pricing discipline are likely to hurt it and the other websites that count on online transactions to make money. In the latest quarter, the company saw flat revenue from standalone air travel, while the hotel segment saw a significant gain. This recent news gives credence to the premise that investors might want to focus on the growth potential in hotel and vacation packages.
All airlines will benefit
In general, all airlines should benefit from the higher fares, but the biggest beneficiaries should be the stocks of the legacy airlines trading at some of the lowest earnings multiples in the market. US Airways and United Airlines trade at forward earnings multiples close to six making them the most attractively priced, but United has a high concentration of California routes with hubs in both Los Angeles and San Francisco that have seen flat to lower pricing. In fact, this might be the reason that United saw disappointing numbers for September while the industry as a whole continued to shine.
United had a small increase in consolidated traffic on a tiny increase in capacity that led to a 0.6-point increase in the load factor, a measure of how much an airline packs a plane with passengers. Typically a higher load factor would be a good sign for an airline, but United only expects passenger revenue per available seat mile, or PRASM, to be flat. Even with fuller planes, the airline isn't able to increase fares like the rest of the industry.
Conversely, US Airways saw a 3.5% increase in September revenue passenger miles, causing the load factor to decline 0.3 points. The key though is that US Airways' PRASM surged 6% versus the same period last year. Delta saw PRASM surge 5.5% with a slight 0.1-point increase to the load factor. Ironically, the two airlines with fewer passengers per plane only saw small load factor declines due to higher fares.
The important news in the airline sector continues to be that pricing discipline is expected to lead to sustainable earnings. With the legacy airlines -- Delta, United, and US Airways -- trading at market-low earnings multiples, the group remains attractive as investments. If the strong stock gains over the last year continue, then these airlines could begin being traded based on these new sustainable income streams.
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