Investment Insider: Stay on the ground as airlines take off

 

Air travel has come a long way since that momentous day on 17 December 1903 when Wilbur Wright successfully achieved something no one had accomplished, powered flight. Little did Wilbur and his younger brother Orville know that their invention would spawn an industry that would enable millions to not only fly 120ft (as the brothers did) but thousands of miles.

Since then there have been hundreds of commercial airlines that have attempted to make a buck or two out of the Wright brothers' invention. However, not many have been consistently profitable. According to Flightglobal, there have been 267 airline failures since 2009.

It seems that the global downturn has taken a heavy toll on airlines. But according to the International Air Transport Association, things may be about to change for the better. IATA has raised its profit estimates for global carriers to £2.5bn this year. Although this is still some 50 per cent below last year's profits, IATA predicts next year's aggregate profit could rise to around £4.6bn. So, could this be a buying opportunity for canny investors?

Airlines unquestionably have a business model easy for investors to understand. They fly aircraft. They sell seats on the aircraft to passengers and capacity for cargo. That's it. However, lurking beneath the simplicity is operational gearing – airlines have to recover high overhead costs before they can make money.

That's why the downturn has been so damaging for many undercapitalised airlines. Many ran out of money as the economic slowdown cut demand for air travel. Consequently, many airlines were forced to fly their planes even when it was uneconomic to do so. However, not all airlines have been affected. Low-cost airlines seem to have unlocked the secret of operational gearing by driving ticket prices lower through intricate yield management programmes that aim to maximise the return.

There are other ways to take advantage of a recovery in the airlines market that do not require investing in airlines directly. John Menzies, the former high-street newsagent, operates Menzies Aviation, the world's second-largest global aviation services business.

It provides a range of passenger handling services that include ticketing and check-in. Menzies is valued at about eight times prospective earnings, which doesn't look too demanding. The prospective yield is an above average 4.2 per cent.

Some claim investing in airlines directly can be a recipe for disaster. Warren Buffett put it succinctly when he jokingly said the Wright brothers' flight was one small step for mankind and one giant step backward for capitalism. I tend to agree, which is why I think staying on the ground may be a better way to invest in an airline recovery.

David Kuo is director of financial website fool.co.uk

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