With earnings season winding down, a lot of the focus is
going to be put on the daily macro-economic news. Each piece of US economic
data is going to be heavily analyzed to determine how it will impact the Fed’s
decision to raise rates. As of now, the futures market is indicating a roughly
54% probability that a rate hike will begin in December. That’s important to
note because the S&P has priced in a December move in rates. If any data
comes out that could indicate the Fed moves sooner, the S&P will surely fall.
Although rates will be moving higher, I don’t see this as a reason to worry
because the Fed will be smart about this. Janet Yellen has already indicated
that just because they begin raising rates, doesn’t mean it will happen
quickly. It could take years for the Fed to increase rates to normalization,
and they will only do so as long as the economy is strengthening, which would
be positive for equities. For now, be disciplined in your stock selection and
look for companies that are undervalued.
The big story last week was the decimation of all the
airline stocks, with the industry losing $10B in market cap on Wednesday alone.
While they all probably should have dropped, none of them deserved to fall as
much as they did. On Wednesday
morning, Southwest Airlines (LUV) sent investors running scared, selling any
and all airlines, after they announced a slight, and I mean slight, increase in
capacity. Southwest announced that they plan to increase capacity from 7% to
8%. That’s right…the 1% increase in capacity was enough send the stock down
about 9%, with American Airlines and United Airlines faring worse. Its almost
as if Southwest never said a word about 7% capacity expansion this year, and
out of nowhere said they would increase capacity by 8%. That news brought back
images of when all of the major airlines got ahead of themselves, leaving many
to file bankruptcy. When one airline raises capacity, others tend to as well
for fear of missing out on customers. That in turn may lower ticket prices, which
investors believe will automatically lower margins, reduce revenues and most
importantly, reduce earnings. My opinion is that this past week seems to have been
one of those situations where investor’s first instincts was to sell and then
ask questions later.
I think this sell-off in the airlines gives you a great
entry point for not just a trade, but also a long-term investment. Investors
are forgetting that airlines were still making a lot of money with oil trading
at $100/barrel, and although the commodity has rallied sharply off the low,
it’s still only trading around $60/barrel. The lower gas prices and 5.4%
unemployment rate is also leading to very strong demand with the industry
expecting record traffic this summer, looking for a 5% increase YoY. If ticket
demand remains high, which I don’t see any reason it wouldn’t, airlines don’t
have to worry about lowering ticket prices to attract fliers, which should keep
margins stable. Additionally, fuel costs, which is the largest expense for
airlines, has dropped by about 35% over the last year. I understand the reason
for worry about airlines announcing capacity increases, but I find it hard to
believe that the same airlines that have fought for years to get back to strong
growth rates, are going to just go crazy and let all of that success unwind.
There are a lot of airlines to choose from and not all are
created equal. My three favorites in the industry are Jetblue (JBLU), Southwest
and Delta (DAL), and I believe all three are strong buys right now. Jetblue is a
leading low cost airline that flies mostly domestically, which will benefit
from the strong US dollar. The stock is trading at just 10x forward earnings
and has a PEG (price-to-earnings growth rate) of just 0.24. Like Southwest
Airlines, Jetblue has strong customer loyalty with a lot of in-flight perks. On
a recent conference call, management cited that they have priced in revenue and
earnings growth for $90/barrel oil, so with oil trading at a third of that, the
company is poised for continued success. Additionally, the company has shown
that it can increase capacity faster than the industry average, while
continuing to grow revenues. On a technical basis, the stock sets up well. Since
crossing above its 50-day moving average, Jetblue has not fallen below that
level, rallying off of it the three previous times. The 50-day MA is $20.01,
which had also been previous resistance before the company reported strong
earnings on April 28, and now acts as support. With the stock down about 10%
from all-time highs, I like Jetblue to rally again.
Southwest Airlines is the only one that I own right now and
furthest off all-time highs, falling 22% since the end of January, with 12% of
that move coming last week. On Wednesday, the stock dropped 9% on 4.5x average
volume, which to me indicates a flush out. At $36.86, the stock is trading
above the 50% Fibonacci retracement of $36.32, which I see holding. Like
Jetblue, Southwest flies mostly domestic, so it will also benefit from a strong
US dollar, sports a forward P/E of 10.13 and a PEG of 0.37. I think you can buy
50% of your position right now, and then wait for a rally to $39, which has
been previous support. If the stock gets above $39 and holds that level for
three straight days, then buy the other 50% of your position.
Lastly, the other airline I like is Delta. The company is
among the cheapest of all the airlines, trading at less than 8x forward
earnings with a PEG of 0.49. While Delta gets more than 25 of its revenue from
overseas, they recently announced that they will be cutting international
capacity to compensate for a strong US dollar, which should go right to the
bottom line. Delta also owns their own refinery business, which gives them a
huge advantage with lower fuel costs than their competitors. Delta sets up
nicely, closing at $43.18 on Friday. There is a lot of support around this
level, with $43.07 being the 61.8% retracement and $43.10 being the 200-day
moving average. If that fails, you don’t have a lot of risk, with additional
support at $40.60, a level the stock has held since gapping above that price on
November 4, 2014. Delta is already 15% off all-time highs so the risk/reward
sets up well.
The bottom line is that the selling pressure that we saw in
the airlines last week was way overdone and not justifiable. But use other
people’s pain for your gain and jump aboard the friendly skies of Jetblue,
Southwest Airlines and Delta.
My current positions: Long
Gilead Sciences (GILD), Starbucks (SBUX), Facebook (FB), Wells Fargo (WFC),
ConocoPhillips (COP), Time Warner (TWX), Twitter (TWTR), NXP Semiconductors
(NXPI), Lockheed Martin (LMT), Darden Restaurants (DRI), Celgene (CELG),
Mobileye (MBLY), Jack In The Box (JACK), Under Armour (UA), United Rentals
(URI), Regeneron (REGN), Restoration Hardware (RH), Apple (AAPL), Southwest
Airlines (LUV), Dow Chemical (DOW), L Brands (LB), Dr. Pepper Snapple (DPS), and
long UnitedHealth Group (UNH) JUNE CALLS, Mobileye (MBLY) JUNE CALLS, and Apple
(AAPL) JUNE CALLS.
Jeff Lewison
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