Time To Buy The Airline ETFs? (FAA, FLYX, USO)

Eric Dutram:  Although Hurricane Irene wasn’t nearly as devastating as some had feared, the storm did knock out power to millions and ground thousands of flights across the Northeast. Yet, the worst of the storm now appears to be over as flights are returning to the skies in major airports in New York, Washington D.C., and Boston, suggesting that the revenues lost to the airline industry could be much less than some had expected [see Three ETFs To Monitor As Hurricane Irene Wreaks Havoc]. In fact, major airline stocks such as Delta, American Airlines, and United-Continental were all up significantly in the first two days of the week, with AMR leading the way higher with a nearly 9% gain.  

These solid gains are in sharp contrast to earlier in the month when airlines stocks were slumping across the board including double-digit plunges through the first eight days of August. This includes a nearly 20% loss for American Airlines and a nearly 15% slump for Delta during the same time frame. These stiff losses came despite a double digit percentage drop in the price of oil during the same time frame, a puzzling situation since fuel represents one of the biggest costs for the industry. For example, since the beginning of May, a broad index of airlines stocks has fallen by 18.3% while the United States Oil Fund (NYSE:USO) which tracks light, sweet crude oil, has slumped by close to 22.8% in comparison [see the chart at the end of the article]. This suggests that at least in the short-term, oil and airlines are more directly correlated than some might have initially thought, a surprising situation given the relative ease with which airlines can extract more profits when fuel costs tumble. Instead, it appears that over the past few months oil and airlines have both declined on fears over the economic situation, plunging on fears over demand more than anything else [Checking In On the Airline ETFs].

Investors in the airline sector were also concerned by Southwest’s recent earnings report which suggested that weakness could be ahead for the key North American market. The company appears to be cutting back flights to many locations in the winter season as well and could be removing planes from service in some markets as it gets its house in order for the AirTran merger. The Texas-based company reported earnings of just 15 cents a share when stripping out gains on fuel-hedging contracts, missing estimates of earnings of 21 cents a share. Nonetheless, the company did see average fares per mile rise by 8.4% and revenues surge by 31%, although much of this can be attributed to the merger with AirTran, suggesting that the near-term future of the company remains uncertain to say the least. ”I’m concerned about the U.S. economy, I’m concerned about fuel prices,” said Chairman and CEO Gary Kelly.

While this pessimism trickled down into other carriers, one could argue that an increase in fuel prices might not be that bad for the airline industry, especially for the larger players that have hedged their exposure to rising jet fuel costs anyway. This is because higher fuel prices could represent a stronger economy, and as we have seen in recent months, weak oil prices can still lead to weakness in the airline industry. Furthermore, several airlines have announced large purchases of planes in recent weeks suggesting that while weakness may be hitting the American market, it is certainly not impacting global and specifically, emerging markets in the same way. In fact, according to data from the Airports Council International, only three of the thirty busiest airports in the world saw declines in traffic from the January to May period of 2011 when compared to the same time frame in 2010. Rather, double digit growth was seen at six of 30 busiest gateways including a nearly 20% gain for India’s busiest hub. This suggests that the gloom for Southwest may either be short-lived or just a case of U.S.-centric weakness, something that many globally focused airlines are not nearly as worried about, potentially meaning that the recent sell-off in the industry is somewhat unwarranted [ETF Plays On Planes, Trains And Automobiles].

Two Ways To Play

For investors seeking exposure to the airline industry, there are two broad options available in exchange-traded form; the Guggenheim Airline ETF (NYSE:FAA) and the Direxion Airline Shares (NYSE:FLYX). Both funds target about 22 securities in the space with exposure to companies listed around the world. FAA’s top holdings include Southwest, Delta, and United Continental, while FLYX focuses in on United Continental, JetBlue, and US Airways for its top three components instead. It is also worth nothing that FAA is far more concentrated in its top ten than the newer counterpart as FLYX devotes 49.5% to the top ten compared to close to two-thirds for FAA.

Furthermore, investors should note that FAA may be a better choice for traders thanks to its higher volume levels while FLYX could be the choice for long-term investors as its expense ratio is 10 basis points lower than its more popular counterpart. With that being said, either product could be an interesting way to play a further rebound in transports, especially considering the low P/E ratios for both funds as both ETFs come in with a ratio less than 13.2., assuming of course that the summer slowdown that equities have been experiencing evaporates and cycles back towards growth in the autumn months [compare FAA to FLYX with the ETF Comparison Tool].

Written By Eric Dutram From ETF Database  Disclosure: Long LUV.

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