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How High Can They Fly\?

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The Airline Sector (XAL.X) lifted off last week and is flying higher again this morning. Part of the group's recent strength is due to the decline in energy prices. Obviously airlines are levered to the price of energy.

But there's more at play in the group than energy prices. Last Friday, United (NYSE:UAL) said it would delay delivery of new aircraft in 2002 and 2003. The company had been scheduled to receive a total of 67 new aircraft in the next two years. UAL announced that it would cut its order to a total of 42 new aircraft for 2002 and 2003. The reduction in orders is expected to save UAL about $2.5 billion. The order cut wasn't a positive development for manufacturer Boeing (NYSE:BA), but it reaffirmed the recent cost-cutting strides by the major carriers.

The government is helping the sector in the wake of the tragic events of September 11. Lawmakers recently passed an aviation security bill, which President Bush will sign later today. And the previously received government aid is adding stability to the airline sector's collective balance sheet. For example, Frontier Airlines (NASDAQ:FRNT) received about $10 million from the government following the disruption in air travel. To put that number in perspective, Frontier reported $7.3 million in income during its most recent quarter. Frontier is an exception in that it's one of the few profitable carriers. But the government aid will obviously positively impact the carriers and improve their financial positions.

The combination of positive developments in the airline sector has been pushing the XAL higher. The index gained more than 17 percent last week and is higher by more than 6 percent at time of writing. The XAL is up big recently, but it's important to note that the index is one of the few in the market that is trading below its pre-September 11 level.

Through this morning, the XAL has retraced almost 50 percent of its decline from September 11. But it still has a lot of room to the upside before repairing the damage done.

I don't think that it's prudent to chase stocks higher after big moves, such as 17 percent in the XAL last week. But I do think that the XAL is one to watch over the intermediate-term. The group gained a significant amount of strength relative to the broader market last week and is looking strong again today. The steep drop in energy prices is a huge positive for the airline business as jet fuel goes straight to the bottom-line. In addition, the major carriers have taken serious steps to reduce costs in order to become leaner, more efficient businesses. The double-whammy in the reduction of costs may position the carriers for several profitable quarters over the next six to nine months.

Eric Utley
Option Investor

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