Airline Stocks Are Flying High Now but Won't Forever

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NEW YORK - JANUARY 12: Airbus A330 approaches at dusk to JFK Airport located in New York, USA on January 12, 2012. Delta is one
Chris Parypa Photography/Shutterstock
Investors are starting to embrace airline stocks again. American Airlines Group (AAL), United Continental (UAL) and Delta Air Lines (DAL) are up 60 percent, 23 percen, and 39 percent, respectively, so far in 2014. All three of the legacy carriers have seen their shares more than double off of last year's lows.

Last week we even saw American Airlines do something that the iconic airline hasn't done in 34 years when it reinstated the quarterly dividend that it suspended in 1980. It's also not the only way that these air heads are returning money to their stakeholders. The boards at American Airlines and United Continental authorized $1 billion in buybacks.

Ascending stocks prices, mailing out dividend checks and cranking out the kind of free cash flow to accommodate 10-figure stock repurchases are as unusual as a flight out of O'Hare or LaGuardia leaving on time. The airline industry is starting to take off, but you may want to respect that "fasten your seatbelt" light.

Cleared for Takeoff

With sector consolidation and modest jet fuel rates helping improve margins, air carriers have been big winners in 2014. And the good times are expected to continue in the near term. Analysts see earnings per share soaring 93 percent at American Airlines this year. It will earn more this year than the carrier's market cap was in early 2012.

It's not the only one expected to make big strides. United Continental's profitability is expected to climb 56 percent this year. Delta isn't growing its bottom line as quickly, but there's always the possibility that analysts aren't aiming high enough here. Over the past year the three leading carriers have combined to beat Wall Street income estimates in 10 of the 12 quarters.

If this was any other sector, flourishing in an ideal climate with mergers making the remaining players even stronger would be the feel-good story of 2014. Unfortunately we're talking about airlines, and we've seen these highs come undone by turbulence before.

Making Our Descent

"Investors have poured their money into airlines and airline manufacturers for 100 years with terrible results," Warren Buffett, arguably this generation's greatest investor, said in 2013. "It's been a death trap for investors."

Buffett was asked about the airlines after merger activity and share prices began to pick up. He was probably being kind. A dozen years ago he had a more vivid reaction: "If a capitalist had been present at Kitty Hawk back in the early 1900s, he should have shot Orville Wright," he reportedly said at the time. "He would have saved his progeny money."

Buffett's argument then was that the industry's high fixed costs, strong labor unions and commodity pricing made it a dangerous area to invest. He should know. He bought some US Air debt in 1989 and was lucky to get out a couple of years later without losing his hide.

Pressures From Consumers, Competitors, Unions

Buffett's concerns are still valid today. Despite the popularity of frequent flyer programs, we're still using online sites to make sure that we grab the cheapest fare on any carrier. This will always be a business where desperate carriers will launch price wars. Sector consolidation helps, but this won't change, because this will never be a monopoly.

We're years removed from the latest organized labor strikes, but unions are working to keep employees well paid regardless of the ups and downs of fuel costs and passenger demand. All of this adds up to planes that need to operate at high occupancy levels to remain consistently successful. It has happened over stretches of time.

Airlines are clearly successful right now. However, there's a reason why Buffett has said that the industry has "eaten up capital over the past century like almost no other business because people seem to keep coming back to it and putting fresh money in."

It could be happening again.

Motley Fool contributor Rick Munarriz has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.



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