Investors may find cheap valuations and improved fundamentals in the airline industry and sector-related exchange traded fund.
On the recent webcast, Why Airlines Have Been Soaring to Record Profits, Frank Holmes, CEO and Chief Investment Officer at U.S. Global Investors, argues that the airline industry could fly as many economic factors continue to bolster the growth outlook and investors can gain exposure to the cheap sector through a targeted ETF.
Over the past year, airline stocks have been moving as oil prices tanked. Fuel is the largest expense for airlines, which makes the sector sensitive to swings in the energy market. [Oil ETFs Plunge to All-Time Lows]
Looking ahead, Holmes argues that a number of other factors could further support the sector. For instance, the aviation sector is expected to contribute $1 trillion to world GDP by 2026.
The growing global economy could support overseas growth opportunities. Specifically, the rising middle class in the emerging markets will fuel more air travel demand. The global middle class is expected to hit 3.2 billion in 2020 and 4.9 billion in 2013, compared to 1.8 billion in 2009.
A dearth in supply and rising demand could also help support better pricing for airliners. Holmes points out that the industry has been consolidating due to businesses closing and greater merger and acquisition activity, which will cause fewer flights. As airliners see increased capacity, many companies have been trying to expand fleets, with Boeing (NYSE: BA) showing a 7-year production backlog for jets. Meanwhile, the industry, for better or worse, added thinner seats, which has increased overall capacity and bolstered revenue.
Airlines are also paying down debt while free cash flow is rising. Debt as a percentage of operating revenues has declined to 41.4% in 2014 from over 65% in 2010. Free cash flow is expected to rise over $15 billion this year from close to zero over the past couple of years.
The industry is also enjoying greater ancillary revenue, or revenue from sources outside of passenger tickets, such as baggages, food, beverage, rentals and wifi, among others. Global ancillary revenue has increased to $31.5 billion in 2013, compared to $2.45 billion in 2007.
“Airline companies are in better financial condition than they have been in years,” Holmes said.
Along with the improved outlook for the industry, airline stocks look attractive in their own right. For instance, income-oriented investors may notice that airline stocks have seen improved dividend-yield growth – the Bloomberg U.S. Airlines Index showed 1-year dividend yield growth of 88.2% for the year ended June, whereas the Dow Jones Transportation Index saw yield growth of 14.1%.
Additionally, the sector shows relatively cheap valuations. Airline stocks have a 7 times price-to-earnings ratio, whereas the broader transportation stocks have a 15 times ratio and the S&P 500 index shows 17 times P/E. JETS shows a 8.3 p/E, according to Morningstar data.
ETF investors can tap into the broad airline industry through the U.S. Global Jets ETF (NYSEArca: JETS), the only dedicated airline industry-related ETF on the market. JETS follows the U.S. Global Jets Index, which uses fundamental screens to select airline companies, with an emphasis on domestic carriers, along with global aircraft manufacturers and airport companies. Due to its indexing methodology, the top four companies American Airlines (NasdaqGS: AAL), United Continental (NYSE: UAL), Delta Air Lines (NYSE: DAL) and Southwest Airlines (NYSE: LUV) make up 49.6% of the fund’s overall portfolio.
Financial advisors who are interested in learning more about the airline industry can listen to the webcast here on demand.