Flying high: Are airline stocks a good investment?

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Signs of an uptick in the airline industry is bringing the consolidation and change in cycle that many fund managers have been waiting for. However while some are buying airline stocks for value and growth, others argue that they continue to destroy value for investors.

The share price of a number of airline stocks have seen a significant uptick since the start of the year, with budget airlines Ryanair up approximately 53 per cent and Easyjet by 63per cent.

International Airline Consolidated Group, the holding company for both British Airways and Iberia, has also seen a 43.5 per cent increase in share price over the same period.

SVM fund manager Neil Veitch notes that the industry itself is experiencing a change in the cycle, bringing with it increased mergers and greater barriers to entry.

“The industry dynamic has turned on its head post-financial crisis – the leasing market has completely dried up and there is virtually no access to new planes,” he says.

“The sovereigns have been forced to prioritise their fiscal position, so the flag carriers are also under increased pressure to become much more efficient. This means cutting back and mergers.”

The manager of the £90.2m SVM UK Opportunities fund has bought International Airlines Consolidated Group in the last three months, on the expectation that the stock’s value could increase significantly.

He says: “With a recovering global economy, and an improvement in the airlines cycle, then International Airlines should do quite well.

“If you assume that British Airways can get back to near its peak margins, somewhere in the region of 50-55 p/e versus a current share price of 2.60, that is potentially quite considerable upside from here.”

According to the latest June factsheet, the fund also holds a 4.3 per cent position in budget airline Ryanair.

JP Morgan fund manager John Baker sees positive “earnings surprises” for budget airline stocks as capacity decreases at the same time as revenues are also increasing from ancillary services.

He says: “A lot of capacity are being taken out of the market in Europe. In the UK for instance, since its peak around 2007-08, capacity is down 7 per cent.

“Less capacity, or supply, in the market means that Easyjet and Ryanair in particular can increase the prices they charge. They are also generating more revenues from ancillary services, such as costs for being able to choose seats on a flight.”

The manager of the £140.2m JP Morgan UK Dynamic and £82.3m Europe Dynamic ex UK funds currently holds positions in Ryanair and Easyjet. He also notes that both airlines have strong balance sheets, while Ryanair has plans to return cash to investors.

He says: “Both have got very significant cash positions and the cash flow that they are forecasting to generate over the next couple of years is also very strong.

“Ryanair announced this week that they are returning €1bn cash to investors over the next couple of years. Some of this had already been communicated to the market but essentially we have got an extra €500m from them. They are going to do this either by buying back their shares or with special dividends in 2014-15.”

Outwith budget airlines, Baker says that International Airlines Consolidated and Lufthansa German Airlines look attractive thanks to cuts in capacity and greater pricing power on transatlantic routes.

However speaking at a recent Morningstar investment conference, chief executive and manager of the £1.5bn Fundsmith fund, Terry Smith, declared that the airline industry “destroys intrinsic value” for shareholders, as demonstrated in figures from International Air Transport Association for 2000-2010.

He said: “All the people who own all of those airlines, waiting for the consolidation play or the change in the cycle, are sitting there owning something that was borrowing money at 7.5 per cent and giving an actual return 2.8 per cent.”