With traditionally high debt levels and a struggle for profitability, airlines rarely come to mind when one thinks of value investments. But when some players in an industry are unloved by the market, their stock prices can become temporarily depressed. Here we will look at two airlines that fit an undervalued profile.
The news surrounding US Airways (UNKNOWN:LCC.DL) recently has almost entirely centered on the airline's proposed merger with American Airlines parent company AMR (UNKNOWN:AAMRQ.DL). While this merger would play a major role in shaping the future of US Airways (which would become American Airlines Group upon the merger), the results of the trial determining whether the airlines can merge are not do-or-die.
While US Airways has strong potential upside from a successful completion of the AMR merger, I see US Airways as having limited downside based upon the airline's strong cash and earnings positions. Trading for a price-to-earnings ratio under 7, US Airways has enough earnings to theoretically support the current share price on its own.
In addition, the airline has nearly $20 per share in cash. Although US Airways still has billions in debt, future earnings should be enough to manage this debt load and possibly reduce it over time. In the event the AMR merger fails, US Airways is still likely to be hungry for expansion and may use some of this cash to acquire a smaller carrier in a deal more likely to be approved by the DOJ.
Alternatively, US Airways could use some of this cash to buy back shares while they trade in the single-digit P/E range. By doing this, US Airways would join the likes of Delta Air Lines and Alaska Air Group, parent company of Alaska Airlines, in launching share buybacks.
Canada's largest airline, Air Canada (TSX:AC.B), has been on quite a run lately as it topped the performance list of the TSX Composite. But even with this impressive run, Air Canada still trades cheap on a P/E basis, especially when future potential is factored in.
Even with shares hitting new highs since 2008, at C$4.47 per share they're still cheap based on a forward P/E ratio. Data from Businessweek gives estimates of C$0.74 for FY2013 and C$0.97 for FY2014. And based on the airline's positive September report, analysts are likely to raise earnings estimates higher over the coming weeks.
One of the reasons for Air Canada's low valuation is investor fear surrounding the airline's debt levels. Not only does the airline have billions in long-term debt, but its pension plan is also significantly underfunded to the point where Air Canada needed a funding extension granted by the Canadian government.
However, Air Canada is tackling these problems by refinancing long-term debt at lower rates lowering interest expense, strengthening the balance sheet, and making financing for the new Boeing 787s more affordable. The pension plan is also being negatively affected by currently low interest rates. However, if interest rates rise in the future, the liabilities associated with the pension plan should fall in turn.
Even with an industrywide rally, there are still compelling values in among airlines. Both US Airways and Air Canada have single-digit forward P/E ratios. Additionally, US Airways has a strong cash position, giving it the ability to pursue a variety of opportunities, while Air Canada's debt refinancing is lowering interest expense while making future financing easier. Investors looking to get into the airline industry at a fair price may want to check out these two carriers.
Alexander MacLennan owns shares of Air Canada, AMR, and Delta Air Lines and also has options on Delta and US Airways. This article is not an endorsement to buy or sell any security and does not constitute professional investment advice. Always do your own due diligence before buying or selling any security. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.