Why the Airline ETF has big Upside Ahead

The U.S. Global Jets ETF (NYSEArca: JETS), the lone dedicated airline exchange traded fund on the market today, is off 4.3% since debuting at the end of April, but investors might want to take advantage of lower prices in JETFs before airline stocks rebound. Some market observers believe that rebound is not far off and has the potential to be significant.

Catalysts include the predictable, such as low oil prices and robust demand for air travel, as well as compelling valuations and rising profits.

Earlier this month, the International Air Transport Association (IATA) “announced an upward revision of its 2015 industry outlook to a $29.3 billion net profit. On expected revenues of $727 billion, the industry would achieve a 4.0% net profit margin. The significant strengthening from the $16.4 billion net profit in 2014 (re-stated from $19.9 billion) reflects the net impact of several global factors, including stronger global economic prospects, record load factors, lower fuel prices, and a major appreciation of the US dollar,” according to Briefing.com.

That robust profit outlook for airline stocks coincides with low valuations. “Analysts expect revenue growth to decelerate sharply to just 2.3% in 2015 from 23.6% last year, but think earnings growth will surge to 98.6% from 27.1%. The P/E of 7.7 is near early April’s 19-year low of 7.3, and its 55% discount to the market is at a 14-year low,” according to Yardeni Research. [Why the new Airline ETF Could be a Success]

JETS’ underlying index shows a forward price-to-earnings ratio of about 9, less than half the P/E on the S&P 500.

“At the end of June a year ago, before fuel prices started tumbling, Wall Street predicted that the big four, which control more than three-quarters of the domestic market, would grow their combined 2015 earnings before interest, taxes, depreciation, and amortization by 7%, to $22.7 billion. Now the forecast is for 40% growth, to $29.2 billion. Yet shares of these carriers are up just 10%, on average, in the past year, following a 21% rout so far this year. All four now sell for less than half the valuation of the Standard & Poor’s 500 index, based on a comparison of enterprise value (market value plus net debt) with Ebitda,” writes Jack Hough for Barron’s.

The most recent issue of the financial magazine featured a cover story on airline stocks, saying the group “could soar up to 50%.”

That may seem like a bold proclamation for airline shares and JETS, which tracks the U.S. Global Jets Index. JETS’s underlying index takes the top four U.S. airlines based primarily on their market capitalization and to a lesser extent their passenger load factor and weights them at 12% each. The next top five U.S. airlines receive a 4% weight. The remaining airline companies meeting the index criteria are then scored based on multiple fundamental factors driven by their cash return on invested capital, sales per share growth, gross margins and sales yield. Each of the four U.S. companies with the highest composite score receives a 3% weighting and each of the twenty non-U.S. companies with the highest scores receive a 1% weighting. [ETF Opportunity in the Friendly Skies]