Airlines Look Priced for Perfection

Tickers in this article: AAL DAL LUV UAL

This article originally appeared on Jan. 28, 2014, on RealMoney.com. To read more content like this plus see inside Jim Cramer's multimillion-dollar portfolio for FREE... Click Here NOW.

Of all the equity sectors I track globally in order to gauge immediate economic prospects, the sector that stands out currently is the U.S. airline industry.

The major airline stocks are all ripping higher today and have been doing so over the past six months. American Airlines is up 4.5% today alone and 65% in the past six months. Delta Air Lines   is up 1.8% today and 50% in the past six months. United Continental Holdings   is up 2% today and 33% in the past six months. Southwest Airlines   is up almost 3% today and 50% in the past six months.

This level of appreciation has sent the price-to-earnings ratios for the sector to levels that in the past would have been associated with technology growth.

American, Delta, United and Southwest have current price-to-earnings ratios of 26, 13, 23 and 25. A long-term trend for the industry, which is mature, is in the range of 10. Only two of these four pay a dividend, Delta and Southwest, both at a low 0.8%.

Everything is indicating that the stocks of these companies are already priced for no consideration of an economic slowdown over the next several years.

The general consensus in the financial media is that consolidation within the industry is going to return pricing power to a reduced number of participants and that travelers will pay up by necessity.

One of the problems with this scenario is that, consolidation aside, since the financial crisis of 2008, passenger miles traveled per capita in the U.S. have not recovered. In 2008, the rate of growth in airline travel peaked at about 10%. After the financial crisis, this abruptly dropped to about minus 3% in 2009. Growth has since recovered to 0%, where it remains today.

The airlines are all buying their fuel forward, while oil is in the $80-$100 range, and booking these prices as a hedge, indicating that they uniformly believe that oil prices, and thus fuel prices, will only rise over the next few years.

When airlines bought their fuel forward in 2009 and 2010, while oil prices were in the $40-$60 range, where prices had fallen after the financial crisis, that was beneficial to their bottom lines. Locking in now at $80-$100, rather than being a hedge, may very well prove to be a catastrophic speculation if economic activity slows or contracts and oil prices fall again.

Even if that doesn't occur, the stocks of the airlines are already reflecting expectations for growth in economic activity and thus passenger miles traveled. Anything that causes those expectations to change could cause the prices of these stocks to plunge.