American Airlines Group Inc (AAL)

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UPDATE: Warren Buffett loves cheap airline stocks, which could get a boost from Trump

2:07 pm ET February 15, 2017 (MarketWatch)
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By Philip van Doorn, MarketWatch

Airlines already have low valuations, so if tax rates fall, they could be even more attractive

The decision by Warren Buffett's Berkshire Hathaway to load up on Apple shares (http://www.marketwatch.com/story/warren-buffetts-big-bet-on-apple-may-have-made-him-11-billion-in-just-six-weeks-2017-02-14) is making big news. But the billionaire investor also put money in four airline stocks.

A tailwind for airlines is that their high income tax rates might fall dramatically if President Donald Trump succeeds in cutting corporate tax rates.

In the fourth quarter, Berkshire Hathaway Inc. (BRKA) built a new stake of 43.2 million shares in Southwest Airlines Co. (LUV), while also adding to its holdings of American Airlines Group Inc. (AAL), Delta Air Lines Inc. (DAL) and United Continental Holdings Inc. (UAL). Most airlines are expected by analysts to post declining profits in 2017 as fuel prices rise. Industry profits are expected to be healthy in 2018, with those four airlines expected to generate double-digit increases in earnings per share.

Don't miss: 20 companies that have met a high bar this earnings season (http://www.marketwatch.com/story/20-companies-that-have-met-a-high-bar-this-earnings-season-2017-02-15)

Tax rates

FactSet estimates that the average effective income tax rate over the past 12 reported months for S&P 500 member companies was 26.4%. The highest U.S. corporate tax rate is 35%, and, of course, many companies pay state and local income taxes as well. It is reasonable to argue that a reduction in the federal corporate tax rate will help some companies more than others, and airlines might be among the biggest beneficiaries.

We decided to broaden our review by looking at the nine airlines included in the S&P 1500 Composite Index, which is made up of the S&P 500, the S&P 400 Mid-Cap Index and the S&P Small-Cap 600 Index .

Here they are, in alphabetical order, with their effective income tax rates:

Airline Ticker Effective income tax rate - 2016*

Alaska Air Group Inc. US:ALK 39.48%

Allegiant Travel Co. US:ALGT 36.53%

American Airlines Group Inc. US:AAL 37.75%

Delta Air Lines Inc. US:DAL 34.10%

Hawaiian Holdings Inc. US:HA 37.95%

JetBlue Airways Corp. US:JBLU 37.58%

SkyWest Inc. US:SKYW 39.37%

Southwest Airlines Co. US:LUV 36.74%

United Continental Holdings Inc. US:UAL 40.74%

Source: FactSet

(For SkyWest Inc. (SKYW), we are showing the effective income tax rate for 2015, because the company posted an operating loss for 2016.)

Trump has pledged to lower the corporate tax rate to 15%. He said Feb. 9 that his administration would be "announcing something I would say over the next two or three weeks" on corporate taxes that "will be phenomenal" for businesses.

Valuation

The S&P 1500 trades for 16.2 times consensus 2018 earnings estimates, according to FactSet, while the industrial sector of the index (which includes the airlines) trades for 16.8 times consensus 2018 estimates. Here's how the airlines stack up, by this measure, and how much analysts expect their earnings to grow in 2018:

Airline Ticker Consensus EPS estimate - 2017 Consensus EPS estimate - 2018 Expected EPS growth - 2018 Closing price - Feb. 14 Price/ consensus 2018 EPS estimate

Alaska Air Group Inc. US:ALK $7.89 $8.61 9% $96.30 11.2

Allegiant Travel Co. US:ALGT $10.96 $12.49 14% $174.85 14.0

American Airlines Group Inc. US:AAL $4.61 $5.35 16% $46.57 8.7

Delta Air Lines Inc. US:DAL $5.23 $5.79 11% $49.86 8.6

Hawaiian Holdings Inc. US:HA $4.83 $5.02 4% $51.10 10.2

JetBlue Airways Corp. US:JBLU $1.82 $2.01 10% $19.66 9.8

SkyWest Inc. US:SKYW $3.09 $3.47 12% $35.05 10.1

Southwest Airlines Co. US:LUV $3.89 $4.68 20% $55.31 11.8

United Continental Holdings Inc. US:UAL $6.77 $8.11 20% $73.74 9.1

Source: FactSet

It appears from these low forward price-to-earnings ratios that many investors still don't trust airlines, but the industry has been stable in recent years, as it has found new ways to make money and avoid cutthroat price competition, following decades of mergers, bankruptcies and other disruptions.

Erick Ormsby, the founder of Alcosta Capital Management, particularly favors Southwest Airlines because of the prospect that its high tax rate will fall, as well as 20% expected EPS increase in 2018 and its overall growth trajectory.

"You have a stable environment, relatively speaking, for an airline that is trading at 12 times earnings," he said in an interview Feb. 14.

-Philip van Doorn; 415-439-6400; [e-mail]

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February 15, 2017 14:07 ET (19:07 GMT)

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