A record number of fliers are expected this Labor Day weekend, which has boosted airline stocks.
An industry group, Airlines for America, has forecast a whopping 16.5 million people will fly on U.S. airlines between Wednesday, August 29, and Tuesday, September 3, in what has become a record-breaking year for air travel.
“2018 has been an exceptionally busy year for air travel, with 20 out of the 25 busiest days ever recorded by the Transportation Security Administration occurring so far this year,” said Airlines for America’s Vice President and Chief Economist, John Heimlich.
This forecast has come at a time when airline stocks are surging, with Delta shares up 8%, and Southwest Airlines up 7.3% for the month, among other airlines experiencing rising share prices.
These two airlines have also seen increased investments from Warren Buffett’s Berkshire Hathaway (NYSE: BRK.A, BRK.B), with the conglomerate buying an additional 10 million shares in Delta and 8.9 million shares in Southwest in the second quarter.
Buffett said airlines were among the “worst sort” of businesses in a 2007 letter to shareholders, as they grow rapidly but require significant capital to generate that growth, earning little or no money. But since then, Buffett has done an about-face and is now the top share holder in Delta and second top shareholder in Southwest.
Buffett’s track record speaks for itself, and his knack for picking money-making stocks makes his holdings a must-know for smart investors. Considering then that he has increased his ownership of both stocks, it’s worth taking a look to see why they are buys now.
What sets Southwest and Delta apart is that both boast impressive trailing 12-month operating margins, with Southwest at 15% and Delta at 12.9%. Compare that to AAL’s and UAL’s trailing 12-month operating margins at 9%.
While neither Southwest nor Delta are immune to the industry challenges of their peers, both have structural advantages that support better operating profits.
Delta has fewer planes than AAL, enabling it to maximize per-seat profit. Delta also said in July that its non-fuel costs should flatten out and turn negative by the end of 2018 which could send its operating margin climbing higher.
While the company did report 9.6% year-over-year revenue growth in the second quarter, its pre-tax income fell by 10.2% largely due to jet fuel costs increasing by 30.7%.
The airline is expanding its roster of transatlantic flights, adding capacity in markets where the carrier has a strategic advantage. The company’s transatlantic passenger revenue per available seat mile (PRASM) has been accelerating over the past year, rising 2.4% in Q3 2017, 7.4% in Q4, and 11.5% in Q1 2018, making it clear why the airline would add additional transatlantic flights for 2019.
These new routes are expected to reach peak profitability relatively quickly, which should help Delta get its pre-tax profits growing once again in 2019.
Southwest, meanwhile, remains one of the best low-cost airlines in the U.S. due to its use of smaller-market airports.
The stock has been hampered by a fatal accident in April, the first on a U.S. airline since 2009, when a plane’s engine broke apart and a fragment of it sliced through a window killing a passenger.
Bookings since then have been down, though Southwest attributes the decline to a reduction in advertising. However, the airline’s low fares and highly regarded customer service help to set it apart from its low-cost rivals.
Southwest boasts the strongest balance sheet in the industry, and has been able to produce robust returns on capital and free cash flow, making it an especially attractive option for investors thinking about getting in on airline stocks.
What’s also interesting about Southwest is its prospects for growth. The company is in the process of opening up new U.S. markets including Hawaii, which could deliver near-term growth, while international markets could deliver a multi-decade growth opportunity.
Currently, Southwest operates in just 14 international locations compared to more than 80 U.S. locations. Southwest CEO Gary Kelly believes the airline has the potential to add as many as 50 new international destinations to its roster over time, which would likely lead to steady revenue and profits increases over the long term.
The average 12-month price target for DAL is $67, which suggests potential upside of nearly 15%. Just last month, Stifel Nicolaus rated the stock a Buy with a price target of $95 – 64% higher than Thursday’s closing price.
While analysts’ 12-month price target for LUV is $67, or 10% higher than today’s price, though Stifel Nicolaus set their price target at $85 – a potential 42% gain.