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Analysis: Navigating through the AMR bankruptcy

airplaneinterior
Tags: AMR Group

A combination of high fuel prices, a loss of business travelers to competitors and labour costs that were $800 million US more per year than its rivals brought American Airlines -- the only major U.S. airline that had not previously declared bankruptcy -- to its knees.

Because American enters into bankruptcy with a stockpile of cash -- $4.1 billion US -- and has said it can still buy new aircraft from Boeing and Airbus, the company could reemerge as a strong competitor by the end of 2012, says Jeff Kauffman, an analyst at Stern Agee.

But in the meantime, one company's bankruptcy spells opportunity for others to profit. Here is an investment strategy to gain while AMR operates in bankruptcy.

BUY BENEFITING COMPETITORS

American will likely cut services on unprofitable routes. And fewer available seats mean that prices could edge up, giving American's competitors more room to lift profit.

Craig Hodges, a fund manager with $700 million in assets under management at Hodges Capital, expects American to reduce its presence at highly-competitive airports like Chicago O'Hare and San Francisco International.

United Continental Holdings stands to benefit the most because it goes head-to-head with American in those well-traveled markets.

"You're starting to see some business come back in the business traveler segment, and that's going to help United Continental become very profitable," he said.

Savanthi Syth, an airline analyst at Raymond James, expects American to pull back on its routes to the Caribbean and Latin America from its Miami hub. That could benefit JetBlue, which has made a big push into the region but currently offers 6.3 million seats in the region compared with 11.2 million for American. If American pulls back, a good chunk of market share could be up for grabs.

Airlines have taken extensive steps to become more profitable, although the crowded competitive field has remained a problem, said Hodges. "This could be a time similar to 2003 with the rails, when demand was finally coming back and there were only 4 of them left," he said.

Following consolidation, companies like Union Pacific traded at $30 per share. By the end of 2007, Union Pacific had jumped 108 percent, compared with a 65-percent jump for the S&P 500 index over the same time frame.

GO FOR THE FIXER UPPERS

American was woefully behind in refurbishing its aircraft in comparison with competitors. But that's changing.

American has more than 200 older model McDonald-Douglas planes in service, and another 120 Boeing 757s that would likely need to be updated, said Syth. The company said that under bankruptcy it will shed leases for at least 24 older planes hand will then refurbish or replace existing aircraft.

Both options will likely benefit companies that provide parts and services like bolts, plastic lining for aircraft interiors and the drink carts that flight attendants push down the aisles, said Michael Sansoterra, a manager at the RidgeWorth Large Cap Fund Analysts said they doubted that Boeing (BA-N) would be impacted.

Among the likely beneficiaries: BE Aerospace, which makes drink carts, plastic lining and other components of aircraft interiors. The small-cap company fills orders for new planes and upgrades. Its stock is up 5.8 percent so far this year. The Wellington, FL-based firm splits the market with a French company called Zodiac, which gives it a steady earnings stream, said Sansoterra, whose fund owns BE Aerospace.

Sansoterra also owns Precision Castparts Corp., a $23.7-billion market-cap company which makes fasteners, bolts and other parts for wide-body aircraft built by Airbus and Boeing. The parts are weight-sensitive, which helps make the planes decidedly more fuel-efficient. The company is up 18.1 percent this year, one reason why Sansoterra's fund is 1.2 percentage points ahead of the S&P 500 over the same time frame.

AIRPORT REVENUE BONDS

Airport-revenue municipal bonds depend on airport revenue sources like parking, concessions, landing fees and terminal rentals to airlines in order to make payments to investors. Major airports like Chicago or Dallas can easily fill American's slots with a hungry competitor, analysts say.

Howard Cure, the managing director of municipal research at Evercore Wealth Management, said that investors often "confuse problems with the airline industry with airports." While the airline industry is very competitive and high cost, with tourism and fuel prices sending them up and down, airports don't have the same operating pressures, he said.

Airport revenue bonds generally yield about 20 basis points (or 0.20 percentage points) higher than similarly-rated water/sewer revenue bonds, Cure said. But with airport revenue bond defaults rare, Cure said that investors can be rewarded without taking on much additional risk.

Buying bonds issued by airports in an investor's home state often offers tax advantages, to boot.

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