Lift in Airline Industry Makes Discounters Attractive

The steady decline in oil prices to below $60 a barrel has given some lift to the airline industry. The Amex Airline Index surged over 3% on September 12, but there remains some concern relating to softening air travel, especially after the foiled airline terrorist attempts in London.

 So, in which airlines should you invest? In my view, I continue to prefer the discount airlines.

 At the top of my list is the granddaddy of all discounters — the one that every player wants to emulate — Dallas, Texas-based Southwest Airlines Co. (NYSE/LUV).

 Southwest Airlines started with three Boeing 737 aircrafts in June, 1971, serving Dallas, Houston, and San Antonio. Today, Southwest is the dominant discount or low fare airline in the U.S. with 400 Boeing 737 aircrafts. Its routes are focused on the U.S. and are generally short haul and high frequency, but there are also long haul routes.

 The carrier focuses mainly on point-to-point routes (direct non- stop, city-to-city) rather than hub-and-spoke service (including indirect flights). This is a significant difference, favoring Southwest.

 The airline industry is not in a growth mode, but the discount area has excellent potential. With all the negative news in the industry, this may be an opportune time to buy Southwest.

 In spite of the carnage in the airline industry, Southwest has reported some decent numbers over the past few years. Its ability to turn a profit year-after-year is impressive. Southwest has been profitable for the last 32 consecutive years. That is truly impressive.

 Its low cost structure and experience at running a discount carrier for over 20 years gives the company an advantage over other low fare carriers and the major airlines.

 Southwest’s forward FY07 estimated P/E of 17.04x its FY07 EPS is reasonable given the situation. Earnings in the FY07 are expected to jump to $0.99 on revenues of $10.37 billion. The airline’s valuation is superior to that of its peer group.

 Other discounters to keep an eye on include Frontier Airlines Inc. (NASDAQ/FRNT) and JetBlue Airways Corp. (NASDAQ/JBLU).