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Bear of the Day: Air France-KLM (AFLYY)

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Today’s Bull of the Day was a US regional airline that is in a position to take advantage of favorable economic conditions while avoiding many of the inherent risks associated with this unique industry.

The other side of the coin is Air France-KLM (AFLYY - Free Report) , an international carrier that’s staring right down the barrel of some of those risks.

The result of a 2004 merger of Air France and the Netherlands-based KLM, AIr France-KLM is a giant in the industry – consistently near the top in terms of revenues, yet often has a hard time turning big revenues into equally big net profits.

Operating large planes over long routes, Air France-KLM has one of the highest cost structures in the industry, especially because of a strike-happy labor force that costs the airline up to 50% more than the labor bill at competitors as a percentage of revenue.

French Pilots union SNPL is threatening another strike this year. Its complaint is not against any specific airline, but rather the possible passage of a law in the UK parliament that would group them together with other labor unions and dilute their negotiating leverage. The threatened week-long walkout would be disastrous to Q2 results at Air France-KLM.

Another big cost risk for a big airline is fuel, and the cost of oil – which has risen more than 50% in the past 5 months – is poised to spike again amid news of the Trump administration’s plans to end waivers to sanctions on purchases of Iranian oil.

In a move intended to economically strangle the leadership in Tehran, the US announced that the waivers - which were originally granted to seven of our most important trading partners - would expire on May 2nd and would not be renewed. Another rise in the price of oil would significant hurt margins at Air France-KLM.

Finally, there’s a wildcard risk associated with airlines that operate Boeing’s 787 aircraft. After bad press associated with Boeing’s smaller 737MAX aircraft when two fatal crashes in 6 months were blamed on the plane’s technology, all countries grounded the planes and flight schedules had to be hastily rearranged at significant cost to the carriers.

Now, there’s focus on potential safety issues with the 787 as well.

Though Boeing denies the claims and no accidents have been associated with the alleged defects, several recent expose pieces have claimed that the 787 suffers from defects from with shoddy manufacturing processes.

Air France-KLM operates 20 787s, and though there’s no reason to believe that the current claims will affect operation of the aircraft, investors will have to be mindful of the risk.

Thanks in large part to cost concerns and other risks, earnings estimates at Air France-KLM have been falling lately, earning the airline a Zacks Rank #5 (Strong Sell).

Due to their huge fixed-cost structures and external risks, airlines can be a challenging industry to invest in. Right now, the cards are simply stacked against Air France-KLM. Investors in the space would be wise to consider a smaller regional player like our Bull of the Day, SkyWest (SKYW - Free Report) , a Zacks Rank #1 (Strong Buy).

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