Market Overview

A Deeper Look Into Airlines, And The Rise Of The 'Global Middle Class'

A Deeper Look Into Airlines, And The Rise Of The 'Global Middle Class'

Airlines are in the midst of a smooth ascent after many of the top dogs in the United States released earnings last week. American Airlines Group Inc (NASDAQ: AAL), Delta Air Lines, Inc. (NYSE: DAL) and United Continental Holdings Inc (NYSE: UAL) all posted beats, while Southwest Airlines Co (NYSE: LUV) managed to match forecasts.

And the U.S. Global Jets ETF (NYSE: JETS) has taken off as well, up 6 percent since the beginning of July. Benzinga spoke with Frank Holmes, CEO and CIO of U.S. Global Investors, which operates the ETF, to discuss the commercial aviation sector.

Conservative Estimates

Holmes attributed the series of earnings beats within the industry to investor bearishness, which may have led to conservative forecast.

He referenced U.S. PMI numbers, which peaked in November alongside the aviation sector. Holmes explained that the level of manufacturing within the country largely determines the amount of business travel, which is a "key component of airline revenues."

He also mentioned "capacity pricing concerns" from a host of analysts on the Street.

Related Link: Can Airline Stocks Fly Out Of Turbulence?

The final reason Holmes suggested that many might have been overly wary of airlines was the Department of Justice's investigation into suspected collusion by the largest companies in the space. According to analysts with whom he has spoken, the case "doesn't really have any teeth." Holmes actually believes that what may look like collusion probably stems from the fact that most of the companies use similar pricing algorithms to maximize their revenues.

Recent Uptick

While the ETF was reflecting some bearishness earlier this summer, its value has been climbing in recent weeks.

Holmes said that the recent progress was due partially to falling oil prices, which are the result of softening manufacturing worldwide. The Brent Crude Oil index has dropped to just over $50 after starting the month above $60. "It's a big win for airlines," he said, for which fuel is a primary expense.

According to Holmes, the big four U.S. airlines -- American, Delta, United Continental and Southwest -- have each seen its revenue per seat mile grow between 4 and 9 percent year-over-year, indicating increased efficiency.

In the third quarter, he said, they are set to show collective free cash flow of $3.5 billion, compared to only $750 million a year ago.

Holmes also cited worldwide demographic changes as well. "The big win has been the rise of the global middle class," he noted, with China and Southeast Asia being the fastest growing regions. "They want to travel," he said, and the developed world has been catering to that desire. Holmes mentioned that many EU countries, led by Spain, have been fast-tracking policy to help Asian tourists enter the continent. Meanwhile, the American government has undertaken similar initiatives.

These converging factors have stimulated a "rise in global travel" that will continue to boost aviators' balance sheets.

'Just a Matter of Time'

Holmes told Benzinga that with "quantitative data mining and simple modeling" becoming an increasingly large part of the investing world, it is only a matter of time before the market appreciates the fundamental opportunity in airline stocks.

Offering among the highest returns on invested capital of any industry worldwide and pursuing repeated share buybacks and dividend payouts, the airline sector looks, in many ways, like a prime investment opportunity, he said.


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