US Airways Group, Inc. (LCC), Delta Air Lines, Inc. (DAL), United Continental Holdings Inc (UAL): Ready for Takeoff?

Fewer flights with higher occupation should have a positive effect on profit margins. Plane occupation is a key variable in the industry; since most of the costs of a flight are unrelated to the amount of passengers on the plane, one more passenger on board means more revenue with almost no cost increase. That’s why airlines make their best effort to ensure they operate with high levels of occupation.

Consolidation is no panacea, but over time it should help when it comes to reducing excess capacity and keeping costs under control. The sector is so plagued with negativity that we could expect expansion projects and new possible entrants to remain subdued for some time, unless until there are some clear signs of improvement in the industry.

The same goes for the stocks in the sector, except for Southwest, which trades at a well-deserved premium thanks to its superior profitability track record. The rest of the group is trading at forward P/E ratios in the area of 5. These valuations reflect the industry’s economic hurdles, but this also means that these airline stocks offer big upside potential if things start turning for the better in the middle term.

Bottom Line

The airline industry, as tough as it is, seems to be moving in the right direction when it comes to reducing excess capacity and increasing profitability. It’s still too early to tell if this consolidation will deliver the results expected by investors, but upside potential under such scenario could be quite big. As they try to finally takeoff after three decades of lackluster returns, airline stocks are worth watching.

The article Ready for Takeoff? originally appeared on Fool.com and is written by Andrés Cardenal.

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