Turbulence ahead for airlines

The economy seems to be improving. That may lead to increased demand for air travel. But airline stocks have nearly doubled since March. Fasten your seatbelts.

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By Paul R. La Monica, CNNMoney.com editor at large

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Airline stocks (XAL) have soared since March, even outshining the broader market's impressive run.
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NEW YORK (CNNMoney.com) -- Happy Labor Day weekend. Or for the 1.5 million of you out there (including me) estimated to be taking a plane somewhere, good luck in the airport.

As any frequent flier knows, the airline industry is, to quote Jimi Hendrix, "a frustrating mess." And about the only thing more frustrating than flying is trying to make money by investing in airline stocks.

Most major carriers routinely lose money, despite the fact that they now seem to charge you extra fees for everything but the pleasure of breathing the pressurized air. JetBlue (JBLU) is the only big airline expected to post a profit this year.

Just about every time the price of oil goes up (and it has soared about 45% since mid-February), the chances for airlines to make money shrinks. And many airlines have been in and out of bankruptcy almost as many times as the Duggar family pops out kids.

So you might be surprised to know that airline stocks have far outperformed the broader market since stocks started rallying this spring. The NYSE Arca Airline Index has skyrocketed more than 80%. The banking sector is one of only a few industries to do better than airlines during this stretch.

What gives? Do airlines have more room to run before they reach cruising altitude? Or are they about to finally start making their descent back to earth?

Well, very much like banks, airline stocks were priced at overly depressed levels. So their bounce shouldn't be a huge surprise given that many investors now think the worst is over for the economy.

"The stocks have had an amazing move since March. But if you go back to that time frame, investors were thinking that the whole industry would go bankrupt," said Helane Becker, a transportation analyst with Jesup & Lamont Securities Corp.

But the hopes of a global economic recovery haven't yet translated into an increase in air travel -- which means investors need to be cautious.

Earlier this week, Continental Airlines (CAL, Fortune 500), US Airways Group (LCC, Fortune 500), United Airlines parent UAL (UAUA, Fortune 500), and American Airlines parent AMR (AMR, Fortune 500) all reported traffic declines in August from a year ago. The one exception to the rule was Southwest Airlines (LUV, Fortune 500), which announced Friday that traffic was up 1% from a year ago.

To be fair, the airlines all have been cutting capacity, which is good news since it should lead to lower expenses. But like other sectors of the economy, slashing costs will only take the stocks so far. Sooner or later, investors will demand to see signs of sales growth.

That's not happening yet. The only major airline expected by analysts to post an increase in revenues this year is Delta Air Lines (DAL, Fortune 500) -- and that's only because of the big boost it got from its merger with Northwest last year.

If the economic recovery is for real though, airlines could start to show increased revenue in short order. As annoying as all these new bag check surcharges are for customers, they could help lead the airline industry out of its rut.

Craig Hodges, co-manager of the Hodges fund, which owns shares of Continental and Southwest, said it is not that much of a stretch to think that many airlines could become profitable if the economy keeps recovering and if oil prices either remain steady or don't head much higher.

"The airlines are finding a lot of new revenue sources. The problem is that it's not evident in their total sales because demand is still weak," Hodges said. "But if demand comes back and oil stabilizes, then airlines could start earning money again."

Becker said that she also thinks sales should start to improve later this year and into 2010. But there are several wild cards that make her a little wary.

"There could be a pullback in the stocks," she said. "Could the economy double dip and we go into another recession? We worry about that. The H1N1 flu could hurt global travel. And is corporate travel coming back?"

That said, Becker doesn't think investors should dump all airline stocks. She said that of the major carriers, Delta is still a good buy. But she prefers some of the smaller, regional carriers as well that have more of a focus on domestic instead of international travel.

She recommends Hawaiian Holdings (HA), Allegiant Travel (ALGT) and AirTran Holdings (AAI). All three reported a profit in the second quarter and are expected to make money for the full year.

Profitable airlines? Imagine that. What's next -- on time arrivals and free pillows? A boy can dream.

Talkback: What do airlines need to do to be profitable more consistently? Are there any airlines that you either enjoy flying with or think is a good investment? Share your comments below. To top of page

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