It’s that magic time of the economic cycle, all over again.  Investors run screens galore for cheap stocks to hide money in during a consumer and credit recession.  One group keeps showing up cheap over and over…. THE LEGACY AIRLINE CARRIERS.

When you run the basic searches these all show up with P/E ratios of well under 10.0 and they all look dirt cheap on a price-to-book ratio on the surface.  Just one small problem.  Those P/E ratios are about to show up as major Negative numbers and "N/A" on screens.  In fact, they won’t be making money for a while as a group.  If that isn’t enough, those price-to-book ratios are about to go to rise rapidly as cash will pay for higher and higher costs while the economic fundamentals go against the carriers.  Many book values will go negative by the end of the year at this rate.

We already saw the problems at individual carriers, but it is actually at every single legacy carrier now.  We cross referenced where many such screens were run and here was what we came up with for the stocks, on a P/E, and price/book ratio on major financial websites:
                P/E and Price/Book (each)

Airline name (ticker)                        YAHOO!      REUTERS      AOL
Delta Air Lines (NYSE: DAL)          2.14/0.25    1.63/0.25    3.64/0.43   
UAL Corp. (NASDAQ: UAUA)          7.61/1.02    9.62/1.03    12.78/1.72
AMR Corporation (NYSE: AMR)      5.56/0.93    5.78/0.93    7.88/1.31
Northwest Airlines (NYSE: NWA)   0.91/0.30    1.64/0.30      – /   –
Continental Airline (NYSE: CAL)    4.91/1.30    5.14/1.30    5.32/1.40
US Airways Group (NYSE: LCC)    2.09/0.69    2.20/0.60    3.25/1.63

The reason all calculations are different is that so many different services have different dates of reference, different numbers for GAAP and non-GAAP EPS, different "book value calculations" and more.  But you get the idea.  These look super cheap when you run the two most basic screens out there.  Now when you run the FORWARD EPS targets from First Call, the picture becomes much different.  Below are the First Call estimates for the coming quarter and then for the coming fiscal year.  As the losses mount and that cash flies out the window, kiss those low book values goodbye:

Airline name (ticker)                QTR/FISCAL EPS ESTIMATES       
Delta Air Lines (NYSE: DAL)            -$0.37 & $0.01   
UAL Corp. (NASDAQ: UAUA)           -$2.75 & -$3.05
AMR Corporation (NYSE: AMR)       -$1.32 & -$3.36
Northwest Airlines (NYSE: NWA)    -$0.28 & $0.10
Continental Airline (NYSE: CAL)     -$0.85 & -$0.69
US Airways Group (NYSE: LCC)     -$1.80 & -$3.29

If the fiscal estimates seem not bad enough, don’t worry because it just means that the analysts haven’t gotten around to downgrading and cutting the estimates further for the outlying quarter.  Joe Public and Corporate Joe are trimming back on airline travel rapidly.  Simultaneously, the price of oil has jet fuel at astronomical levels. $70 oil was pressuring the airlines.  $80 oil was hurting the airlines.  $90 was a real pinch.  $100 and above, well that’s just a killer.  Airlines are having to create new bilking mechanisms of charging for checked baggage, figuring ways to charge for bad food. squeezing more seats on to each plane with less and less room, phone reservation charges, and other "fees."  The only alternative is to raise face value and nominal prices across the board, but passengers just go to the next cheaper ad rates even if it is the same after all the "other fees."

Unfortunately, like it or not, the balance sheets of all the legacy air carriers are about to start looking uglier than 2,000 of bad road.  We’ve seen four smaller airlines implode over the last two weeks.  Those won’t be the last.

Dare we ask what the systematic implications are when many of these these legacy carriers start canceling all of the new plane orders?  The Fed already gave a selective bailout to the financial sector.  The government gave major checks out to keep the airlines solvent after September 11, 2001.  After oil prices wreak havoc this year, it very well may be time to get for the legacy carriers to get a second bailout in a decade.

By the time these airlines can actually reach their would be super-mergers, it may just be too late.

Jon C. Ogg
April 8, 2008

Jon Ogg produces the Special Situation Investing Newsletter.  He can be reached at [email protected] and he does not own securities in the companies he covers.

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