I’ve not considered investing in the airline industry until now. Whenever we think of the airline industry we think of a volatile, cyclical market. We think of high capital costs, and companies which are, at the end of the day, making low profits or loss-making.
In fact, Warren Buffett used to decry investing in the airline industry so much he said that if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favour by shooting Orville down.
The big shake out
So what has changed? Well, firstly the big shake out that followed the Great Recession has left an industry that is slimmed down, fitter and a lot more profitable. International Airlines Group (LSE: IAG), which owns world-leading brands British Airways and Iberia, has been a prime example of this.
Both British Airways and Iberia have been transformed from what were once bloated and out-moded businesses to companies that are streamlined, profitable and that look to the future. They have a modern fleet, and are some of the most valued and premium brands in the airline industry. IAG is now steadily increasing passenger revenue and reducing staff costs. This has resulted in a company that was once loss-making but is now hugely profitable.
The low-cost revolution
Then there is the low-cost revolution. Low-cost airlines have airplanes that are almost always full, they provide the basic service with no frills, they avoid the busiest and most expensive airline hubs, and thus they charge low prices yet make a profit. In this industry my pick is easyJet (LSE: EZJ). This company’s share price has been rocketing as passenger numbers, turnover and profits just keep on increasing.
Even though the share price has increased a lot already, the P/E ratio of this rapidly growing company is still just 15, falling to 13 the following year. I would still rate the shares a buy.
The globalisation of air travel
A trend people are only just now spotting is that the growing middle classes of emerging and frontier market countries are starting to travel. The sheer numbers of these new global tourists means that global air travel is, erm, taking off.
This means international airlines such as IAG are benefiting. But business is also booming for aero engine maker Rolls-Royce (LSE: RR) (NASDAQOTH: RYCEY.US).
Rolls-Royce happens to be the market leader in aero engines. This is a business where innovation is key, and Rolls-Royce is widely recognised as being the technological leader in airplane engines.
The result of Rolls-Royce’s proactive approach to innovation is that the company’s Trent range are the engines of choice in modern airplanes. They are the most fuel efficient and reliable engines in the industry.
Rolls-Royce has been increasing its earnings per share at a rapid rate. This growth means that, even though the share price has quadrupled, the company is still not expensive, being on a forward P/E ratio of 17. My view is that the shares are now fairly priced. This is perhaps a share to add to the watch list, ready to buy on the dips.
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> Prabhat owns none of the shares in this article.