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Airline Stocks Ready for Takeoff

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Turnaround may finally be within reach.

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Airlines haven't exactly been flying high for the last few months, but some analysts think the sector is well-positioned to get off the ground.

Legacy carriers and discount airlines alike have been plagued by high fuel costs, liquidity problems, and aging technology. The rocky economy and an unemployment rate over 10% haven't helped these behemoth corporations pull it together, despite massive efforts on the part of the carriers and industry organizations to set things right through consolidation, cost cutting at every possible turn, and even meetings with the bureaucrats in Washington. (See also, Airlines Cope by Consolidating)

But some industry gurus say now is the time to put your money back in the sector because the turnaround is finally on the horizon. Morgan Stanley analyst William Greene points to a lifting of liquidity risk at some of the most badly damaged airlines, as well as a moderately favorable oil price.

"We also believe that we are on the cusp of a stream of positive catalysts for the group," said Greene in a recent note to investors. "Therefore, we believe investors will be hard-pressed to identify a better entry-point for the cycle call in the coming months."

Those positive catalysts Greene is referring to are upcoming guidance updates, investors days, fourth-quarter earnings, and traffic reports like the ones Continental Airlines (CAL), US Airways (LCC), and AirTran Holdings (AAI) released this week showing that the November year-over-year mainline load factor, or the percentage of available seats that are filled with paying passengers, was actually up at all three airlines (even if it was just slightly).

On Wednesday, Greene upgraded both AMR Corp (AMR), the parent of American Airlines, and UAL Corp (UAUA), United Airlines holding company, to Overweight from Equalweight. He points out that these two carriers were perceived to have the worst liquidity risk and therefore will have some of the biggest gains when the turnaround comes.

Virtually all of the major airlines issued stock, refinanced, or pushed off delivery of new planes as a way to raise liquidity in recent months. Greene also mentioned in his note that the 2009 Morgan Stanley Corporate Travel Manager Survey suggests a tick-up in business travel in the new year.

He also wrote: "We do believe that the airline industry is inching closer to the end of the down-cycle. We firmly believe revenue trends have bottomed, which ultimately should improve industry fundamentals as we begin to look to 2011."

Morgan Stanley isn't the only firm touting the coming resurrection of the industry from the proverbial ashes; Avondale Partners analyst Bob McAdoo told Minyanville that the airlines "are a play on the economic recovery."

He said that all of the airlines have positioned themselves to deal with the lesser revenue stream that is currently trickling onto their balance sheets and that they should fair well when that trickle becomes a flood as the economy recovers.

"Pretty much all of the carriers have done sufficient amount of work on their balance sheets so that liquidity and worrying about bankruptcy are no longer major issues," said McAdoo. "My favorites are the two that have been beaten up the most, as if there was a problem with liquidity, and have yet to recover: US Airways and AirTran Airways."

McAdoo believes that these two airlines will do the better than the rest in the industry. He has an Outperform rating on both stocks.

In a note published on Monday, JPMorgan analyst Jamie Baker points to the fact that member airlines of the Air Transport Association, an industry trade group whose members transport 90% of the US airline passenger and cargo traffic, already had improvements in revenues in October.

"October ATA mainline revenue rose 7.4% from September, meaningfully ahead of the average 3.2% improvement seen in recent years," Baker wrote. "In fact, one would have to reach back to 2003 (when demand was recovering from its pre-war dip) or 2004 (SARS recovery) to find anything approximating the September-to-October improvement witnessed in 2009." He added that this was a sure sign of demand recovery for the industry.

Baker expects ATA mainline revenues to improve by as much as 8.5% in 2010. He maintains an overweight rating on Continental, AMR, Delta, AirTran, UAL Group, and Alaska Air (ALK).

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