Friendly Skies Could Be Attractively Valued Skies

The Dow Jones Transportation Average has traded slightly lower to start 2017, indicating that transportation stocks are lagging the broader industrial sector, which has delivered some year-to-date upside.

Airline stocks have not been immune to transports' laggard status. For example, the US Global Jets ETF JETS is down 0.14 percent year-to-date, but that is better than the 1.3 percent shed by the Dow Jones Transportation Average.

Airline Investment Thesis

Things are changing for the better when it comes to the airline investment thesis. In fact, one of the biggest stories out of the airline industry last year was that Warren Buffett ended a decades-long aversion to airline stocks.

Southwest Airlines Co LUV, United Continental Holdings Inc UAL, Delta Airlines, Inc. DAL and American Airlines Group Inc AAL are the top four holdings in JETS, combining for nearly half the ETF's weight.

“Among the U.S. airlines we cover, United looks the most attractive from a valuation standpoint, followed by American and then Delta,” said Morningstar in a recent research piece. “We like United’s new management team and believe that the turnaround story at the Chicago-based carrier has not yet played out. The stock is trading at a 0.89 price/fair value. On the other hand, Southwest continues to look slightly overvalued at a price/fair value of 1.11. Investors seem to be ascribing a premium to Southwest based on its historical performance without recognizing fundamental changes in the carrier’s business model and in the business model used by its peers.” 

Texas-based Southwest, the largest discount carrier, has previously been mentioned as a potential takeover target for Buffett's Berkshire Hathaway Inc. (NYSE: BRK-A) (NYSE: BRK-B).

Some Specifics

The underlying index for JETS, the U.S. Global Jets Index, “uses a smart beta strategy to track the global airline industry. The index uses fundamental screens to determine the most efficient airline companies” according to US Global.

“While the recent downward pressure on oil prices could exacerbate near-term fare weakness as airlines give away cost savings in the form of lower ticket prices, we think decreases in fuel prices should still be viewed as a positive over the mid- to long term,” said Morningstar. “Corporate tax reform could also be another positive for the U.S. airlines — particularly after their net operating loss carryforwards burn off in 2018-19 — due to limited overseas earnings and high effective tax rates. With these potential catalysts on the horizon and the sell-off underway, we think investors should give airline stocks another look.”

The United States Oil Fund LP (ETF) USO is down almost 14 percent year-to-date, which should be a boon for JETS because fuel is the largest input cost for airlines.

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