Will the Next Airline Rally Be Overseas?

Investors in North American airlines were treated to a strong 2013, with returns of almost all large carriers beating the S&P 500 Index. But while I still see a lot of potential on this side of the Atlantic for numerous reasons, repeating the same multibagger gains seen since mid-2012 will be more difficult for North American airlines going forward, since prices have been pushed so much higher.

Investors looking to find the next airline rally still have opportunities and I believe some of the best are in Europe.

European carriers
With Europe slowly emerging from recession, European airlines have had a rough few years. But as the continent returns to growth, even if it's slow at first, air travel could see a major demand boost.

Air France-KLM (NASDAQOTH: AFRAF  ) has been beaten down by the recession as the French flag carrier has reported billions in losses over the past few years. But the airline's "Transform 2015" plan aims to slash costs and boost profits by, you guessed it, 2015. Cost cutting has helped to drive the multibagger gains seen at Air Canada (TSX: AC.B  ) in 2013. Shares of the Canadian airline rallied after it noted that cost savings were coming in above previous guidance. These savings have also helped to drive Air Canada's earnings, moving the airline from an avoid-like-the-plague investment to a star of Bay Street.

Air France-KLM already has a major network established, so effective cost cuts and an economic rebound could go a long way to increasing future earnings. But some investors are uncomfortable with Air France-KLM's debt load and may prefer Deutsche Lufthansa (NASDAQOTH: DLAKY  ) instead. The German airline is being affected by the slowdown in the European economy but resides in a country with one of the most stable fiscal situations in Europe. As the European economy regains its footing, Deutsche Lufthansa is in a prime position to benefit from increased business and leisure travel demand.

Another European carrier investors should look at is International Airlines Group (NASDAQOTH: ICAGY  ) . The company was formed out of the merger of British Airways and Spanish carrier Iberia in early 2011. Both carriers still operate under their own brand names, and apparently their earnings performance has as much in common as their brand names.

In the spring of 2013, British Airways showed its return to health by posting a profit of around 1 billion euros. However, poor performance at Iberia managed to wipe out that profit with a similar loss. By investing in International Airlines Group, investors get an airline with one foot in the U.K. and its other foot in the sluggish Spanish economy. On the bright side, this makes the airline one of the best choices for a recovery in the eurozone periphery. (Aegean Airlines could also work for investors wanting to play Greek aviation, but shares are more difficult to obtain in the United States.)

International Airlines Group is also set to have its worldwide network improved by the US Airways/ AMR merger that created American Airlines Group (NASDAQ: AAL  ) . American Airlines has been a longtime member of OneWorld alongside British Airways, and the merger with US Airways will add US Airways' routes to OneWorld. This will give all members of the alliance better opportunities utilizing the U.S. market.

Time for a rally
Airlines have a large cyclical nature to them, so it's no surprise that the slowdown in Europe has depressed their share prices. But just as European airline shares fell along with the economy, they have the potential to rise as Europe recovers.

As an added bonus, some carriers have taken this time to streamline operations to survive the recessionary environment. Airlines that have made operational improvements stand to see these changes realized to their greatest potential once demand strengthens. When investors consider investing in Europe's recovery, I believe European airlines are definitely worth a look.

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