Tuesday, June 24, 2008

US Airlines: A Put on Oil?

Having grown up around aviation, (with a father who was an air traffic controller and private pilot) it's always been a fascination. As an investor however, I've typically stayed away from airlines: its just a fundamentally difficult business, to put it mildly. Heavy capital requirements, and typically strangling levels of debt don't mesh well with fuel costs rising at alarming rates. While some, such as Southwest, have a great track record, and seem to really know how to profitably run an airline, that's the exception and not the rule.

When the industry took it on the chin after oil breached $135, and panicky operators announced they'll now charge for baggage, we began to view the industry a little bit differently. While the risks of banktruptcy for some of the players seem to grow with each passing day, perhaps there may be some opportunity, however skewed the risk/reward profile may appear.

We now view the airlines as a way to play the oil bubble. First, this assumes there actually is an oil bubble, as we do. Second, it assumes that you can identify an airline that, save the oil issue, has the chance to survive.

That being said, we've recently initiated a small position in US Airways. With $2.07 billion in cash at the end of Q1 (how much they have burned since is a concern), this company may be able to withstand the pressure from oil for awhile. The company does have $3.1 billion in long-term debt, but the next major maturity is $249 million, in 2013.

Don't get me wrong, this is not based on the notion that oil prices will begin to fall in the next couple of years, because by then, it will be too late. Think of this as a put option on oil, with an embedded expiration; that being US Air's bankruptcy if oil continues it's march skyward.

Don't enter into this one lightly. The risks are incredibly high, and based almost solely on the notion that:
1. oil prices will pull back, and
2. airline stocks will react positively.

*The author has a position in US Airways. This is neither a recommendation to buy or sell any securities. All information provided believed to be reliable and presented for information purposes only. The author will not trade any of the securities mentioned (buy, sell, short) for at least two weeks following the date of this post.

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