Personal Finance: Ebola fears create entry point for airline stocks

photo Chris Hopkins

Americans are understandably concerned about the potential for an outbreak of the Ebola virus in the United States. While the situation is clearly dire in West Africa, public health officials here are justifiably confident in their ability to stanch the spread if the disease gets inside the U.S.

Meanwhile, some stocks are taking a hit as investors attempt to divine winners and losers in the battle against the virus. Airlines in particular have sold off on speculation over potential travel restrictions or hesitancy of travelers to board what one wag described as a "flying petri dish." Despite assurances from medical professionals, some shareholders are bailing out, and that could provide an opportunity for patient investors to pick up airline shares at a discount.

It wasn't that long ago that any recommendation to invest in U.S. airlines was justly derided. It has taken over 30 years for carriers to adjust to deregulation and the bracing rush of competitive market forces. President Jimmy Carter was confronted with a heavily regulated, protected and uncompetitive industry in which 10 large airlines divvied up most of the business, and Uncle Sam guaranteed a 12 percent profit on flights that were just over half full. To his everlasting credit, Carter deregulated the industry in 1978 and ushered in an era of painful restructuring for the carriers and relentlessly cheaper flights for the public.

In real terms adjusted for inflation, the cost of an average round-trip domestic flight including change fees and checked bags has fallen by 35 percent since deregulation. This market-driven victory for passengers came at the expense of the carriers, who collectively lost $60 billion between 1979 and 2011.

Today, the industry transformation is nearly complete. Consolidation and restructuring have necessarily reduced the number of competitors, and more importantly the number of empty seats. Meanwhile, renegotiated labor contracts and more efficient aircraft are holding costs down. And the easing in global oil supplies and the concomitant decline in fuel costs stand to fatten the coffers even more. They year 2013 turned out to be a record for the industry as it soared to a $12.7 billion dollar profit.

Airline stocks tend to be somewhat more volatile than the market, as the past month has illustrated. The three major legacy carriers, American (AAL), Delta (DAL) and United (UAL), all saw double-digit percentage selloffs in late September on Ebola fears. Despite a rally last Friday due to lower oil prices, the stocks are still down between 6 and 8 percent. Such temporary declines are common in the umbra of a possible health epidemic or rumors of a terrorist threat. But investors (as opposed to speculators) seek out attractive long-term fundamentals on sale at a discount price. That description fits the airlines, especially if they suffer further fear-based declines.

Value investors might want to dig a little deeper into the supply chain to look at who owns the planes. Aircraft leasing companies exist for the sole purpose of buying big jets from Boeing and Airbus and renting them out to the airlines. These behind-the-scenes players in the passenger transport business have suffered a bigger, if equally unwarranted, selloff, falling by around 15 percent since early September. Given the solid outlook for air travel, the beaten-down leasing companies look interesting at these levels. Pure-play names include AerCap (AER), AirLease (AL) and small-cap firm Aircastle (AYR), which sports a dividend of nearly 5 percent.

The Ebola threat will be subdued and eventually eradicated. But air travel is here to stay and the skies today are much friendlier to investors.

Christopher A. Hopkins, CFA, is a vice president for Barnett & Co. Advisors.