The Lowdown on the Airline Sector

The airline industry is once again pressured by the surging fuel costs. In recent sessions, the price of oil surged to a record above $80.00 a barrel driven by a decline in U.S. crude inventories and gasoline. The Organization of Petroleum Exporting Countries (OPEC) also increased its daily production quota by 500,000 barrels in an effort to stem the price increase, although it had little effect on rising prices.

 On Monday, the airline sector was further hampered after The Goldman Sachs Group, Inc. (NYSE/GS) said that the higher fuel costs could negatively impact earnings in the airline industry. Goldman, which is bullish on oil prices, increased its prediction for oil to trade at $80.00 and $90.00 per barrel for 2008 and 2009, respectively. Should prices trend higher, as Goldman believes they will, the foreseeable future for airline stocks may be murky.

 We are seeing a pickup in travel, although increased competitive pricing pressures are impacting margins.

 The reality is that the airline sector as an investment at this time is still not that viable. The risk is too high. The industry fundamentals are precarious. There are better areas in which to invest your capital. I prefer airline makers and parts companies like The Boeing Company (NYSE/BA) and BE Aerospace, Inc. (NASDAQ/BEAV) as a play on the aviation turnaround.

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 But should the situation calm down, I do favor the discount airlines.

 At the top of my list is the granddaddy of all discounters and the one every player wants to emulate, Dallas-TX-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 some 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.

 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 give the company an advantage over other low fare carriers and the major airlines.

 My advice right now is to steer clear of airlines, especially given the rising oil prices.