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Phillip: Cheaper Oil Makes Some Airlines A Buy!
Aspire, Hot Picks | 20 April 2015
By: Lim Si Jie
Articles (169) Profile

2014 was not a good year for most airlines. Neither was it for the three months into 2015 so far. The latest mishap with Germanwings has once again wavered our confidence in airlines. Is it time to bail on airline stocks? After all, Sir Richard Branson once said, “If you want to be a millionaire, start with a billion dollars and launch a new airline.”

Despite that, is now a good time to be a contrarian and pick up quality airline stocks that are on discount?

APAC Airlines Share Price

Crude oil prices have declined from $110 per barrel range in June 2014 to about $50 per barrel.

Fuel takes up a large percentage of an airline company’s operating costs. It is common knowledge that airlines are the prime beneficiaries of lower crude oil prices. Furthermore,  airlines have generally benefited from the lower energy prices.

Source: PSR, Bloomberg

Delayed Effects Of Oil Prices

Although hedging policies vary across companies, airlines generally hedge some of their fuel price exposure. Since the drop in energy prices took place in 4Q14, one can only expect the impact to happen in 1Q15 and, maybe even 2Q15. This can be clearly seen through the 4Q14 results where oil price was about $100 per barrel.

Breakeven Load Factor

Breakeven Load Factor = Expense / passenger capacity

Breakeven load factor is used as a gauge for an airline’s operational efficiency. The chart shows the spectrum of operational efficiency among listed APAC airlines. According to Phillip, these break-even load factors should see a “decline over the next two quarters” in benefitting from the positive impact of lower fuel prices.

Source: Bloomberg

Past Poor Performance

Source: Bloomberg

As can be seen in the tables above, almost all airline stocks (excluding dividends) has negative to low single-digit annualized returns. This group also benefit from “survivorship-bias”, which means that it already excludes those airlines that have already delisted or gone bankrupt (eg, Malaysian Airlines, Skymark) and scores of airlines that were private and never came public before going bankrupt.

Noteworthy Quality Airlines

However, poor long-term performance does not mean that one should not invest in airlines. On the contrary, Phillip believes that there are many opportunities to invest in airlines. The best times to invest in airlines are when they are in times of crises. Nevertheless, it is a challenge to pick out the airlines that can survive crises.

Phillip noted that some airlines are exceptionally volatile with stocks routinely being multi-baggers or performing poorly. Flag carriers Malaysia Airlines and Thai Airlines have been exceptionally volatile over the past 20 years as they neared bankruptcy and were bailed out. These are examples of airlines that require more speculation.

There are also high quality stocks like Singapore Airlines (SIA) which represents a great investment opportunity. SIA is currently priced at a fair value and provides more stability for longer term investors.

Si Jie is no stranger to investing having started his journey at a young age. He is heavily influenced by acclaimed investors such as Benjamin Graham, Peter Lynch, and John Rothchild.

Please click here for more information about this author.

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