Delta: Remember What Gordon Gekko Said
Following a strong fourth-quarter earnings report, shares of Delta Air Lines (NYSE: DAL) are surging almost 7% on what is already double the average daily volume. Making today's gains all the more impressive is the fact that shares of Delta were up about 15% year-to-date heading into Wednesday.
That's nice, but it still pays to remember Gordon Gekko's initial reluctance when Bud Fox pitched the idea of taking over Blue Star Airlines. Basically, Gekko said bigger investors than he had been burned by airlines and if the fictitious example doesn't work then consider the fact that even Warren Buffett was lucky to barely eke out a profit a long time ago in U.S. Air (NYSE: LCC).
In other words and no pun intended, but airline stocks come with baggage and that baggage makes them risky plays for anyone other than short-term traders.
Delta, the largest U.S. carrier, was able to boost fourth-quarter profits despite rising fuel prices by raising fares and reducing the number of flights offered. In a way, that's turning commercial air travel into a commodity and then artificially creating demand by trimming supply.
The gambit worked, for one quarter at least, but pesky labor and fuel costs aren't going anywhere anytime soon. In fact, the fuel price situation could worsen if oil prices spike. Each $1 increase in the price of a barrel of oil costs the global airline industry $1.6 billion.
Said differently, if oil futures rise to $110 from $100, that will cost airlines $16 billion or roughly double Delta's current market value. According to the statement issued by Delta this morning, the company had operating expenses of $7.6 billion in the fourth quarter with roughly $2.5 billion of that attributable to fuel.
To its credit, Delta, less than seven years removed from its 2005 bankruptcy filing, is one of the best run U.S. airlines. The company wisely scuttled pensions for pilots and has been reducing capacity to pare costs.
Along those lines, Delta shareholders can only hope the company doesn't make a move on AMR Corp. in an effort to get its hands on American Airlines. American is planning to spend almost $750 million on pensions and retiree medical benefits this year and the company has unfunded pension liabilities of $10.2 billion, according to the Fort Worth Star-Telegram.
That's a great reason to not make an acquisition right there. And for those are bearish on airline stocks, there's a great trade out there. Long oil and it doesn't have to be through the futures market. In the past two years, the Guggenheim Airline ETF (NYSE: FAA) was down almost 9% before the start of trading today while the Energy Select Sector SPDR (NYSE: XLE) was up about 25%. In the past year, the gap widens to XLE being slightly positive while FAA is down almost 26%.
FAA and its constituents, Delta included, just face too many headwinds to be excited about these stocks for more than a few days or weeks.
Traders who believe that airlines have more upside, might want to consider the following trades:
- Short the U.S. Oil Fund (NYSE: USO).
- Long FAA, which also features international carriers.
- Long Delta outright.
Traders who believe that airlines will falter, may consider alternative positions:
- Short FAA.
- Long the ProShares Ultra Oil & Gas (NYSE: DIG)
- Long XLE or some of its top holdings.
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