Despite some nagging doubts, most institutional investors are hanging on to their airline stocks during the plethora of merger talks on both sides of the Atlantic.
"All this merger gobbledygook is going to overshadow some solid fundamentals," said equity analyst Julius Maldutis at CIBC World Markets, New York.
Many money managers view airlines as a value sector expected to show strong second-quarter earnings.
"At this point, I'm wondering why United Airlines started all this off," said Nick Redfield, transportation sector portfolio manager at Banc One Investment Advisors Corp., Columbus, Ohio.
The offer by UAL Corp., parent of United Airlines, to buy US Airways Group Inc. for $4.3 billion seemed to set off a chain reaction of merger talks and rumors of talks. AMR Corp., parent company of American Airlines, has been in talks with Delta Airlines Inc. and Northwest Airlines Corp., while leading European carriers KLM Royal Dutch Airlines and British Airways PLC are in merger negotiations.
As a result, some stock prices have experienced minor turbulence. UAL stock rose less than two points -- to 54 5/16 -- on June 8 from May 24, the day the US Air merger deal was announced. Shares in AMR fell about 11/2 points between May 24 and June 8.
KLM saw its stock gain in price after the merger talks announcement June 8 -- to E29.7 from E27.7.
So far, only British Airways shares have remained stable, around 3.9.
Growth through mergers
Most say the likelihood of mergers is slim. Yet with megahubs already in place, CIBC's Mr. Maldutis noted, "the only way you can get growth is through mergers."
Mr. Maldutis, like most other investors interviewed for this story, believes either all or none will be approved by the federal government. He's more inclined to think it's the latter.
Mr. Maldutis' firm owns 1,000 shares of UAL, 31,000 US Airways shares, 165,000 AMR shares and 2,000 Delta shares, according to Thomson Financial Securities Data.
Portfolio managers at Independence Investment Associates Inc., Boston, which owns about 710,000 shares in UAL, according to New York-based research firm The Carson Group, have been sitting tight.
"You have to take the position that nothing's going to happen on a near-term basis, so you're still focused 100% on what the fundamental earnings are going to be," said Paul McManus, senior vice president.
Regardless of the merger talks, Mr. McManus believes the second half of the year is going to be better than the first for the sector.
He believes airlines face a difficult task of pleasing a diverse crop of constituents -- something necessary before a merger could occur. "The airline industry's got a lot of constituents. It's got passengers, it's got shareholders, it has employees, and it has the government. It's tough to satisfy all constituents."
Too much control
Sean Katof, portfolio manager at INVESCO, Denver, also said he would be surprised if the mergers went through. He believes the mergers would lead to too much control of individual cities by individual carriers, hurting consumers.
"I have a feeling the government will come from that perspective," Mr. Katof added.
But, he said, if the mergers were to happen, it would be a "clear positive" for the airline industry because it would lead to less competition and more pricing power.
INVESCO owns 1 million shares of British Airways and 51,000 UAL shares, according to Thomson Financial data.
Timothy Moloney, an industry analyst at Banc of America Capital Management Inc., St. Louis, is focusing on determinants such as oil and jet fuel prices and the overall economy rather than on acquiring companies and takeover candidates.
"Airline stocks remain undervalued," Mr. Moloney said.
According to Thomson, Banc of America Capital's parent, Bank of America Corp., has 655,000 shares of UAL; 61,000 shares of US Airways; and 919,000 shares of Delta.
Banc One's Mr. Redfield is against the UAL-US Airways deal, partly because it will be costly to implement a no-furlough policy, as UAL has promised all employees except managers.
"I don't see this as being tremendously beneficial to shareholders, but it could be beneficial to the industry," he added.
If mergers do happen, he expects his firm's bets on Alaska Airlines and Northwest Airlines to pay off, because both firms could be potential merger candidates. Regional airlines also will be winners because competition will increase in non-hub cities such as Columbus, Ohio; Indianapolis; and Des Moines, Iowa.
Most of Banc One's holdings in UAL (32,000 shares), US Airways (23,000 shares), AMR (130,000 shares), KLM (12,000 shares) and British Airways (140,000 shares) are in retail mutual funds and index funds, Mr. Redfield added.
In the case of American Airlines, one analyst has taken a dim view of the stock because of consolidation.
At New York-based Salomon Smith Barney Inc., analyst Brian D. Harris downgraded AMR immediately following the announcement of the United-US Airways deal.
Mr. Harris said AMR has the most to lose from a UAL/US Air merger because of the strategic challenges to AMR to increase traffic, particularly at airports such as Chicago's O'Hare and Dallas/Fort Worth.
Mr. Harris, whose firm was an adviser to US Airways in the merger talks, predicts there's a 60% chance of the UAL-US Air merger going through.
Salomon Smith Barney remains bullish on US Airways, Northwest and Continental Airlines stock.
CitiGroup, the parent to Salomon Smith Barney, owns about 2 million shares of American Airlines; 152,000 shares of United; 3 million shares of US Airways; and 101,000 shares of Northwest, according to Thomson Financial data.
Wait and see
In London, Tim Rees, director of U.K. equities at money manager Clerical Medical Investment Group, is waiting to see how successful U.S. airline consolidation is before pinning any hopes on a BA-KLM deal.
Mr. Rees believes it is likely the BA and KLM merger will go through, depending on the resolution of governmental and labor issues. But for now, Mr. Rees doesn't see any way to calculate the merits of the merger directly into share prices.
He plans to hold the 30 million shares of British Airways stock in his firm's portfolios.
Ned Gray, portfolio manager at ValueQuest/TA, Boston, which owns stock in both British Airways and KLM, views the merger as a good thing from a shareholder's perspective.
"Both of these carriers need sources of incremental growth. Any help they can get on the cost side is to their advantage," Mr. Gray said. He does worry, however, that the two carriers (with hubs in northwest Europe) "may be too far away from the center of the action in terms of intra-Europe traffic."
Last year was a down year for both stocks, but prospects had started to brighten even before the merger talks began, said Mr. Gray. Both stocks are up significantly, he said. KLM is up almost 70% from early May, and British Airways is up about 40% since February.
The firm has 200,000 shares in British Airways, and 250,000 in KLM.
Through it all, he has held his positions and intends to stand pat until the dust settles.