Value Stock Reboot in Airlines as the Easy Money Has Already Been Made

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The airlines sector in transportation has done very well in this recovery. It turns out that lowering capacity, merging rivals, increasing airfares, and upping the charges for just about every aspect of what customers get is great for business. The problem is that the earnings reports from Southwest Airlines Co. (NYSE: LUV) and United Continental Holdings Inc. (NYSE: UAL) are not really reflecting these trends any longer. Value stock investors are going to demand even more going forward, and there is some reason to believe that the major gains may be met with more profit taking ahead.

Southwest Airlines actually posted a drop of nearly 2% in its profits from a year ago down to $224 million or $0.31 in earnings per share. Its revenues were up only 0.6% to $4.6 billion. While Southwest remains better hedged against wild fuel price changes versus some peers, its revenue per seat mile was down by 2.2%.

Southwest does not nickel and dime its customers to death like other airlines and its baggage and change fees are far more lenient versus peers as well. If it is not going to have much growth, passengers may have to wonder if Southwest will capitulate and become as aggressive in bilking its customers as the other airlines do. Southwest shares were down 2.4% at $13.43 in mid-day trading against a 52-week range of $8.51 to $14.56. The consensus analyst target price was $15.17 going into earnings.

United Continental posted a rise of 38% in its quarterly net income to $469 million or $1.21 in earnings per share. Revenue was up less than 1% at $10 billion, and its per-seat passenger revenue rose only 1% against a capacity drop of 2%. Its fuel prices were down about 8%. United Continental’s stock price was down even more than Southwest, with its drop of 4.6% to $33.37 against a 52-week range of $17.45 to $36.74. Analysts had a consensus target price of $35.32 going into earnings.

Before the drop on Thursday from earnings, these airlines have been great performers in 2013. Southwest shares were up almost 35% and United Continental shares were up by almost 50% year-to-date. What is obvious is that shareholders have enjoyed handy gains in these stocks. Unfortunately, airlines see their profitability wiped out in recessions and we know how sensitive they can be around terrorism or reports of accidents that result in fatalities.

The real question is what valuation is fair for the airline sector after today’s profit taking. United Continental trades at 9.9-times expected 2013 earnings and trades at about 6.75-times expected 2014 earnings. Southwest trades at 13.3-times expected 2013 earnings and trades at 11.2-times expected 2014 earnings. Airlines were literally trading around 5-times or 6-times expected earnings as recently as last year. That being said, the pullback should be of no real surprise. You probably shouldn’t be surprised if you continue to see profit taking as investors may think that the easy money has been made in airline stocks.