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Consumer Discretionary

Change is in the Air

By Elliott H. Gue, on Nov. 28, 2013

Sir Richard Branson, the British entrepreneur who founded Virgin Atlantic and Virgin America airlines, once quipped that the easiest way to become a millionaire is to go into the airline business as a billionaire.

History suggests Branson has a point: In 2002 alone, US air carriers lost more money than they earned in cumulative profits since deregulation in 1978.

Remember PanAm, TWA, Eastern Airlines, People Express and Independence Air? These are only a handful of the major air carriers that went belly-up after deregulation. Even many of the dominant legacy carriers have emerged from bankruptcy and reorganization process at least once.


Source: Bureau of Transportation Statistics

The major US airlines haven’t operated profitably since deregulation ended the cozy world of high, fixed fares and government-regulated competition over routes.

But change is in the air. Despite lackluster economic growth, US airlines have remained consistently profitable–an impressive feat when you consider that the price of jet fuel has soared 140 percent since the beginning of 2009.


Source: Bloomberg

Excess capacity had plagued US airlines prior to the industry’s recent turnaround; too many carriers were flying too many planes over too many routes. Periodic fare wars were the norm in this intensely competitive environment, shrinking already thin profit margins.


Source: Bloomberg

But the major US airlines’ available seat miles (ASM) on domestic flights have declined since the 2007-09 economic downturn. Legacy carriers have grounded older planes, cut less profitable routes and right and right-sized their fleets to match demand.

At the beginning of 2008, six legacy air carriers still flew US skies: AMR Corp’s (NYSE: AAR) American Airlines, Continental Airlines, Delta Air Lines (NYSE: DAL), Northwest Airlines Corp, United Airlines and US Airways (NYSE: LCC).

The subsequent mergers of Delta Air Lines with Northwest Airlines Corp and United Airlines with Continental Airlines reduced the number to four dominant carriers.

Meanwhile, the US Dept of Justice earlier this month cleared the merger of American Airlines and US Airways after the carriers agreed to divest takeoff and landing slots at Washington, DC’s Reagan National and New York City’s LaGuardia airports.

Recent consolidation within the US airline industry has reduced domestic capacity, moderating the cutthroat price competition that had plagued the business for decades.

As anyone who’s flown recently with one of the major domestic airlines can attest, reduced airline capacity and industry consolidation have resulted in fuller aircraft and higher airfares–a winning recipe improved profitability.

Passenger yields, which measure how much an airline earns per mile flown, have climbed over the past five years, suggesting that the US airline industry has finally taken off after being grounded by post-deregulation headwinds.


Source: Bloomberg

But the airline industry’s checkered past means that many investors failed to recognize the extent to which competitive dynamics and carriers’ profitability had improved until the stocks had already soared.

When we highlighted Delta Air Lines in the Jan. 19, 2013, issue of Energy & Income Advisor, a number of readers dismissed our bullish outlook for the company. (See Cleared for Takeoff.)

And some who were receptive to the story worried that the weak US economic recovery would hamper demand for air travel, especially the high-margin business travel that butters the legacy carriers’ bread.

Naysayers also cited concerns about the elevated prices of crude oil and jet fuel.

The critics were wrong.

Airline stocks have shrugged off weak economic growth and elevated fuel costs to deliver huge gains this year. Shares of Delta Air Lines, our favorite, have returned 111 percent since we published Cleared for Takeoff on Jan. 19, 2013.

There’s an old saw on Wall Street that stocks climb a wall of worry. That is, when the market finally recognizes a trend, it’s often too late jump aboard.

We’re always on the lookout for undervalued industries and stocks that stand to benefit from improving fundamentals or other overlooked upside catalysts.

Home Remodeling Takes Off

Roger Conrad and I speak at numerous conferences and for dozens of investor groups in the US, Canada and beyond. (We look forward to talking to many of you at the upcoming World MoneyShow Orlando.)

Oftentimes, the permanent bears are the most popular speakers at these events; predictions of impending doom, market crashes and a declining US dollar always attract a dedicated crowd–even when the market continues to march steadily higher. 

Bearish commentators have warned that the Federal Reserve’s plan to scale back quantitative easing and the consequent increase in interest rates would kill the nascent recovery in the US housing market and stifle recent uptrends in residential construction and home remodeling.

This scenario hasn’t played out.

In fact, spending on home remodeling should remain robust over the next few years because homeowners who delayed purchases and upgrades during the downturn finally have started to loosen their purse strings.

Private residential fixed investment measures spending on the construction of new houses and expenditures related to the home maintenance, repairs and improvements. These activities tend to contract during recessions and pick up when economic growth accelerates. 

Since 1959, private residential fixed investment has averaged about 4.5 percent of US gross domestic product (GDP).

Fixed residential investment climbed to an all-time high of more than 6.5 percent of GDP during the 2002-06 housing boom, before collapsing to a postwar nadir of 2.5 percent of GDP in the subsequent bust.


Source: Bloomberg

This swing from one extreme to the other has led to significant pent-up demand for home repairs and upgrades, fueling strong earnings growth for a number of companies that supply services and equipment related to home remodeling and improvement.

For example, Whirlpool Corp (NYSE: WHR) reported strong third-quarter earnings and has generated a total return of almost 15 percent since we added the appliance manufacturer to our Wealth Builders Portfolio in the Aug. 12 article, Consumer Discretionary is Advised. By comparison, the S&P 500 has returned about 7.5 percent over the same period.

Our Wealth Builders and Lifelong Income Portfolios contain numerous examples of underappreciated growth stories that continue to gain currency in the market, including:

  • A leading manufacturer of automobile components that improve an engine’s fuel efficiency–a real boon in a world of elevated gasoline and diesel fuel prices. The stock has gained about 25 percent since we spotlighted the company in July.
  • A health care company that’s poised to surprise to the upside in 2014, thanks to the bungling of the Healthcare.gov website.
  • A health care outfit with no exposure to Medicare reimbursement, health insurers, the Affordable Care Act (ACA) or health care exchange enrollment. This company boasts a 40 percent market share in a niche industry that’s growing like gangbusters.
  • A major financial firm that stands to benefit immensely from rising US interest rates–a great hedge for the income-oriented fare in your portfolio.

Subscribe to Capitalist Times Premium today to learn more about our top stock picks.

Elliott H. Gue is editor of Capitalist Times and Energy & Income Advisor.

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11/20/13: MoneyShow — Elliott Gue, Energy Transportation Growth, Yield and Value
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