Airline Stocks Are Still on Sale

By Markets Fool.com

Airline stocks soared throughout 2013 and 2014, as investors became more confident that consolidation was driving a long-term improvement in airline industry profitability. Shares of one of the industry's top performers, Delta Air Lines , have nearly quadrupled since the beginning of 2013.

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DAL Chart

Delta Air Lines 2-Year Stock Chart, data by YCharts.

Industry conditions continue to improve, primarily due to the steep drop in oil prices since September. Earnings estimates for most airlines remain quite conservative, as analysts have not fully incorporated the recent oil price decline in their models. Yet most airlines trade at lower earnings multiples than the average of 17 times forward earnings for the market as a whole.

As a result, despite the tremendous performance of most airline stocks in the past two years, many airline stocks are still "on sale." These include not only Delta, but also low-cost carriers like JetBlue Airways and ultra-low cost carriers like Volaris .

The Delta cash machine
Analysts are currently estimating that Delta's EPS will surge nearly 40% to $4.62 this year. Delta shares ended last week at $46.88: down more than 6% from the all-time high set last month and only 10 times the average 2015 earnings estimate.

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Delta's 2015 earnings growth will be supported by a massive drop in its fuel bill. As of early December, Delta estimated that its 2015 fuel expense would be down $1.7 billion year over year, even after accounting for hedging losses. In 2016 and beyond, Delta expects $3 billion of annual fuel cost savings.

However, oil prices have continued plummeting in the past month. Jet fuel prices have fallen about $0.40 since Delta's presentation. At today's jet fuel price, Delta's long-run annual fuel cost savings would be at least $4.5 billion and its 2015 savings would be in the $2.5 billion-$3 billion range.

Delta is on track to realize billions of dollars in annual fuel cost savings.

So far, Delta has succeeded in keeping unit revenue growing (albeit slowly) despite falling oil prices, while keeping non-fuel cost creep to a minimum. It also has credible plans to keep unit revenue growing in 2015 by cutting unprofitable capacity in Japan and reallocating it to more profitable markets like the U.K.

All of these factors mean that Delta is likely to meet or exceed analysts' current estimates. Moreover, its strong free cash flow will allow it to buy back a significant amount of stock at today's low earnings multiple. This should drive Delta stock even higher over time.

Earnings soaring at JetBlue
Low-cost carrier JetBlue hasn't been as successful as Delta in the past couple of years. It missed its target for return on invested capital in 2013 and has warned that it will likely miss the target again for 2014. JetBlue stock has more than doubled nonetheless, as overall industry profitability has improved and airline earnings multiples have risen.

In November, JetBlue outlined its plans to improve earnings by $450 million annually, primarily by adding 15 seats to its fleet of A320s and charging checked bag fees for customers buying the cheapest tickets.

JetBlue will add 15 seats to each of its A320s between 2016 and 2018 to cut costs. Photo source: JetBlue Airways.

Furthermore, JetBlue will benefit even more than Delta from the recent fall in jet fuel prices, because it does not hedge as aggressively. JetBlue's year-over-year fuel cost savings could exceed $500 million -- that's more than its total expected 2014 pre-tax profit.

Some analysts are concerned that JetBlue could give away some of its fuel savings in the form of lower fares. However, given the extent of its fuel cost savings, JetBlue is still likely to double its earnings year over year. Moreover, most of the benefits of its profit improvement program will kick in between 2016 and 2018, driving further profit upside.

In spite of this rosy outlook, JetBlue stock currently trades at less than 12 times analysts' current 2015 earnings estimates. This makes it a great bargain.

Volaris: Turning the ship around
Lastly, Mexican ultra-low-cost carrier Volaris could be the biggest beneficiary of all in a low fuel-price environment. After all, its business model relies on using low fares to stimulate demand among people who don't regularly fly.

Fuel also represents a higher proportion of costs for Volaris than for Delta or JetBlue, so it will see the largest margin benefit from falling fuel costs. Nevertheless, the average analyst estimate for Volaris' 2015 EPS has barely budged in the last 60 days, even as jet fuel costs have dropped by about 40% (or $1 per gallon).

Volaris may see the biggest benefit from lower fuel prices of any U.S.-traded airline.

Volaris stock trades for about 16 times expected 2015 earnings: roughly in line with the market. However, analysts don't seem to have incorporated the recent drop in fuel prices into their earnings estimates for Volaris yet.

Additionally, Volaris' strategy to shift capacity to the U.S. (where demand is stronger) is working, as evidenced by improving load factors. Over the next few quarters, Volaris is likely to benefit from rapidly rising unit revenue and rapidly falling unit costs, boosting its pre-tax margin from the low single digits to the mid-teens.

Bargains all around
In short, the recent fall in oil prices could have a dramatic impact on airline profitability that is not fully reflected in most airline stock prices. Importantly, a few years of lower oil prices could have a beneficial long-term impact on growing airlines like JetBlue and Volaris by making it easier for them to attract new passengers and gain market share with low fares.

For more mature airlines like Delta, the recent drop of oil prices will provide a short-term windfall. This will boost Delta's already industry-leading free cash flow, allowing it to return a lot of cash to shareholders. Thus, no matter what type of airline stocks you prefer to invest in, you have great options for 2015.

The article Airline Stocks Are Still on Sale originally appeared on Fool.com.

Adam Levine-Weinberg owns shares of Volaris and JetBlue Airways and is long June 2015 $7.50 calls on Volaris. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.