Many investors are focused on the price of oil and trying to time an entry back into the commodity. The fact that crude is down more than 50% from its peak in the summer of 2014 intrigues investors with what I believe is a false hope of mean reversion.
The argument of mean reversion could hold if the price of oil in the past was determined by demand and supply. But the truth is that the price was influenced by OPEC. When supply outstripped demand, they would cut down on supply to keep the price of oil at a high level.
This methodology broke down after Russia failed to collaborate with the rest of the organisation and no limits were placed on supply. This led to a sharp decline in the price of oil which now reflects its true price. I am of the view that the price of oil will remain under pressure and at low levels for a prolonged period of time.
So instead of trying to catch a falling knife and miss the forest for the trees, investors should start looking at companies which will benefit from a low oil price. An industry which immediately comes to mind is that of the airlines.
The first thing I appreciate about this industry is, that on average, 40% of operating costs relate to fuel. With fuel at such a heavy discount to where it was in previous years, this surely should tick one of the boxes that makes airlines worth looking into.
Another positive for European airlines is the weak Euro. It is true that a weak Euro makes the price of jet fuel more expensive for a European airline than an American one, however, the weak Euro also makes a European airline more competitive compared to their foreign peers.
Some investors may argue that a weaker oil price will go in the pockets of the consumer rather than shareholders as the airline reduces its fares and pays higher wages to its staff. Although these things will happen in the future, it will not happen imminently and nor do I believe that it will happen with the same aggressiveness as the drop in the price of oil. Keep in mind that for the consumer to benefit, there must be clarity on the direction of the price of oil which we do not have at the moment.
Apart from that, the fact that we are forecasting better global growth rates means that the argument for ticket prices to at least remain at current levels is strong.
Although legacy carriers (LC) face competition from low cost carriers (LCC), a lower price of oil does not necessarily mean that LCC will cut their prices because their cost base ex-fuel will increase. Another reason is that they have a higher percentage of hedged fuel in 2015 compared to LC.
Three companies I recommend in the airline industry are Deutsche Lufthansa, Delta Airlines and easyJet.
Apart from the obvious advantages that all three companies will benefit from in the current environment, Deutsche Lufthansa will benefit from a weaker euro. I believe the share price is not reflecting its potential due to the company’s legacy of strikes which will probability intensify now that the fuel price has come off.
However the management team have proven to shareholders that their best interest is the performance of the company even at the detriment of what employees want. If they manage to settle these disputes in a way which is fair for both parties, the price will continue to gain positive momentum.
Delta has come a long way and if there is a company which ticks all the right boxes, it has to be this one. Management have turned a company which was on its knees into a reputable company which other airlines can only learn from.
Lastly, easyJet competes in the low cost business and has a business model which is not burdened by strikes and inefficiencies. It has a competitive cost advantage over LCs as well as has a strong foothold in the business sector.
This article was issued by Kristian Camenzuli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.