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3 Airline Stocks to Buy Despite Headwinds

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The second-quarter 2016 earnings season has ended for airline companies. Although quite a few companies in the space including key players like Delta Air Lines, Inc. (DAL - Free Report) , American Airlines Group Inc. (AAL - Free Report) and United Continental Holdings, Inc. (UAL - Free Report) delivered better-than-expected earnings, the fact remains that the sector is plagued with multiple headwinds.

Headwinds Overshadow Earnings Beats

The sector is amid severe stress at the moment and it is evident from the fact that despite the earnings outperformance, stock prices of the companies have remained passive. For example, Delta, in spite of the bottom-line outperformance, continues to carry a Zacks Rank #5 (Strong Sell) and has seen its stock price go down by over 11% since its earnings release on Jul 14.

The headwinds vary greatly, from the surge in terror attacks, uncertainty following the Brexit vote in June, unit revenue issues, technical glitches to name a few. The unfortunate escalation in the frequency of terror attacks has affected airline stocks massively due to the associated security fears resulting in a decrease of air travel demand. Additionally declining ticket prices too have the potential to hurt revenues of carriers.

Moreover, the Brexit vote and the subsequent uncertainty put airline stocks at risk, particularly those with considerable exposure to the U.K. due to fears related to slackening demand for business travel. The aftermath of the Brexit vote are well exhibited by the projection of Lufthansa (DLAKY - Free Report) , another Zacks Rank #5 airline stock, that travel demand to Europe has been waning following multiple terror attacks and the uncertainty following the Brexit vote. The German carrier also stated that advance bookings, especially on long-haul Europe-bound routes, have been impacted.

Apart from the abovementioned issues, unit revenue related problems continue to hurt stocks in the space with very little signs of any respite. Furthermore, computer glitches have also proved to be a nuisance disrupting operations and causing undue harassments to passengers. 

The headwinds are well displayed by the fact that the NYSE ARCA Airline index has declined over the past six months. The Zacks Industry rank of 244 (among 260+ groups) carried by the Transportation-Airline segment is further evidence of the tough times being endured by the stocks in the space. In view of this gloomy backdrop, it is no surprise that the bottom-line outperformaces for carriers have failed to find favor among the investors.

Some Tailwinds Remain

Despite the challenges enveloping the space, we highlight some positives for investors interested in the sector. Cheap oil has been a huge benefactor for airline stocks for quite some time. Cheap oil has aided the bottom-line of carriers significantly in the form of huge savings. This has strengthened carriers’ balance sheets leading to increased investments aimed at improving flying experience of passengers apart from hiking dividend payouts/buybacks along with profit sharing payments.

Although oil prices have been weak for quite some time (since mid-2014) and consequently have been priced in, this major tailwind continues to be the main factor behind the considerable year-over-year earnings growth for carriers. Currently, oil prices are hovering around the $45 a barrel mark, a long way off the $100+ a barrel witnessed two years ago. With oil prices not anticipated to touch the highs of mid-2014 anytime soon, this factor will continue to aid carriers’ bottom-lines going forward.

The bullish forecast by the International Air Transport Association for the airlines industry for the full-year 2016 is also driven by the assumption of weak oil prices. Moreover, Airlines for America expects that U.S. carriers will make hay in the upcoming Labor Day holiday period (Aug 31 – Sep 6) with travel demand projected to increase 4% on the back of low air fares.

We are also positive on the U.S. Department of Transportation's decision to allow major US- based carriers to operate flights to Cuban cities. Once operational, the top line of the concerned carriers will be benefitted immensely due to new route additions as Cuba is a favorite tourist spot.

How to Pick Winners?

The above commentary clearly reflects that despite headwinds all is not lost for airline stocks and there exists few hidden gems in the space which investors can unearth. The stocks have the potential to generate handsome returns.

However, given the vastness of the airline space and with most stocks struggling, it is by no means an easy task to identify the few bright spots. We have utilized our Zacks Stock Screener  to pinpoint such stocks. The Zacks Rank, which justifies a company’s strong fundamentals, can come in really handy.

Our Choices

Latin American carrier Copa Holdings (CPA - Free Report) , which performed impressively in the second quarter, reporting better-than-expected earnings as well as revenuesis our first choice. The carrier carries a Zacks Rank #2 (Buy). The forward price-to-earnings (P/E) ratio for the current financial year (F1) is 18.47, lower than the industry average of 19.90. The Zacks Consensus Estimate for 2016 has improved 17.4% to $4.45 per share over the last 30 days.

Skywest Inc. (SKYW - Free Report) , headquartered at St. George, UT, operates as one of the major regional airlines in the U.S. SkyWest reported impressive numbers for the second-quarter 2016, comfortably beating both the earnings and revenue estimates. The carrier holds a Zacks Rank #2. The forward P/E ratio for the current financial year is 10.54. The 2016 Zacks Consensus Estimate has improved 4.7% to $2.65 per share over the last 30 days.

ANA Holdings Inc. (ALNPY - Free Report) based in Tokyo offers air passenger and air courier services. The carrier carries a Zacks Rank #2 making it a good investment choice. The forward P/E ratio for the current financial year is 11.76, much lower than the industry average. Earnings for the company are expected to grow over 20% this year.

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