Airlines Rally but Interest Lags

 | Nov 26, 2013 | 12:30 PM EST
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Nobody likes a chest pounder, but I'm going to keep coming back to this airline theme until I get some kind of indication that people are listening.

The airlines are galloping to new highs. United (UAL) touched $40 Monday, Delta (DAL) just relentlessly marches upward and U.S. Airways (LCC) is consolidating around $24 to $25. You might have heard that the government agreed to not block the LCC/AMR (AMRQ) merger in exchange for the merged airline giving up its gates at Washington Reagan and LaGuardia. If you look at this cynically, you might imagine that lawmakers are concerned about having to pay high prices themselves when they fly home on recess. Is there any other way to look at it?

A merged LCC/AMR, even without DCA and LGA still is going to be the most powerful airline in the world. There is little doubt that they, along with the rest of the industry, are going to raise prices. The great thing about that is that they have massive pricing power because ticket prices have been going down in real and nominal terms for decades. In two weeks I am flying to Phoenix to see family for $460. That's about 25% more than a few years ago. I won't even notice it.  Most consumers won't.

Mark Perry, economics professor at University of Michigan, now at the American Enterprise Institute, has done a lot of work on airline ticket prices.  In 2011, the average total fare (including baggage fees) was $365.23, versus $611.76 in 1980 -- without even adjusting for inflation!  Think about how remarkable this is, especially when considering the massive increases in fuel costs over the same period of time. This is the miracle of capitalism when freed from regulation. Consumers benefit handsomely -- and businesses are forced to get lean and mean.

Economic forces are shifting, however, and the airlines have found that they have some ability to increase margins. And they will. Even tiny increases in ticket prices can be a huge addition to the bottom line. This is why the airline stocks have been rallying so strongly.

The great thing is -- nobody, outside of a few smart hedge fund guys -- is talking about it!  Most of the investing world is used to airlines going bankrupt one after another, year after year. Warren Buffett (someone whose opinion I don't respect) thinks they're not investable. Many people agree.  Sentiment on the group continues to be horrible even after a year and a half of gains. Most people don't even know these stocks exist.

It's pretty rare that I get a trade like this right, but I have owned the airlines for about a year now, and I am sitting on big gains. I have no desire to take profits or to overwrite. And if the government decides to re-regulate them (not currently on the table, but it will be if ticket prices keep going up), then I like them even more. To regulate an industry is to protect it. Airlines were unimaginably profitable the years they were regulated.

You want to start an argument at Thanksgiving dinner?  Be sure to bring up religion, politics, or airline stocks. Uncle Herb will tell you about his mistreatment at the hands of the TSA and Aunt Ethel will complain about the baggage fees. And everyone at the table will miss this trade simply because flying is such an unpleasant experience. That's more gravy for you.

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