Tuesday, September 20, 2005

A PHOENIX RISES OUT OF ASHES

Like the mythological Phoenix that rises out of the ashes, the legacy airlines are ready to rise. Obviously, AMR and CAL are the strong players here. UAL has been poorly managed for a long time; even after its rise from bankruptcy, it may have problems. DAL, NWAC, and USAir (purchased by AWA) have and will cut costs during bankruptcy and will live again.

When airline deregulation took effect in 1979, the door was opened for start-ups to jump right into the fray. Most did not last very long. There are certainly notable exceptions but the small carrier is up against powerful forces.

The legacy carriers own the prime landing gates, they connect to all the major cities, they offer international flights and bonus free miles and extra discounts on competitive flights.

The following points were made by Morningstar: CAL increased sales by $1 Billion Dollars from 1999 to 2004. AMR and CAL continue to cut costs with the latest quarter showing reductions of 4.3% and 5.4% respectively. Morningstar asks the question, "Can you imagine flying from Chicago to London on Southwest with your spouse sitting 15 rows behind you?"

Morningstar does not recommend airline stocks. I suppose one could say ownership of airlines is just too scary. This airlines supports $22 of debt for each dollar of equity!

Even though CAL has dramatically cut costs it continues to battle extraordinarily high fuel costs like the other carriers. Under the circumstances, the company made a profit last quarter but will likely fall back into the red this quarter. Cash flow is better than profits but with huge net loss carry forwards, the company will not show taxable profits for many years to come (this is a good thing).

Standard and Poors rates the company a STRONG BUY. The Standard and Poors investable quotient is 96%!

The stock is technically weak. Relative strength is rock bottom.

Keeping with my belief that the best buys are made on bad news, my family sold shares in Sprint (S) today and purchased shares in CAL. It is hard to let go of a 800% winner! However, like my great grandpa said, "The best time to get into the chicken business is when everyone else is getting out". EBAY, GOOGLE, MSFT, Time Warner, Comcast, Vonage, ESPN, Disney, and many more companies are getting into the phone business. Competition is going to be brutal. These many players are going to fight SBC, VZ and other established phone companies for market share. Profits are going to be hard to come buy for a number of years. EBAY, and GOOGLE, will likely offer free calls in exchange for lead generation fees.

On the other hand, the pace of new airline start-ups has dropped. Many have tried, a few have succeeded and available venture capital is largely gone. Grandpa always liked the idea that not only did the price of chickens go up but the price of chicken feed went down. The airlines continue to dramatically lower costs. More importantly, the average fare is now going up! Planes are flying near capacity. Business is expanding world wide. The tiny discount tourist seats are giving way to business class seats. First class cabins are being expanded. Consumers of high definition TV are seeing the beauty of the earth and are excited about seeing the world.

I am willing to make a wager that fuel prices are substantially lower within two years. I would not want to bet on fuel prices in six months or a year but give me three years and I will make it a substantial bet. Drop the price of fuel to the surviving carriers and you will see substantial profits drop to the bottom line. You will see the Phoenix rise up out of the ashes!

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