U.S. Global Jets ETF (JETS): Airlines Tradable, Not Investable

Note: This will be the first in a series of articles on the airline industry. I hope you will follow along as I cover each of the major airlines in America and provide commentary on how I view each as an “investment.”

Background

It started when I was a teenager. I naturally thought I was smarter than I really was, knew everything I needed to know about the stock market, and had a strong curiosity about everything related to the airline industry. I studied route maps, timetables (okay dating myself a little), and equipment types used by airlines on particular routes. I was fascinated by the history of airports with large hubs and the economics, geography, and airlines that drove them to either be highly successful or ultimately the waste product of consolidation.

In the interest of full disclosure, I should share that the first investment I ever made after my parents setup a brokerage account for me was in an airline; JetBlue Airways (JBLU). I was obsessed with David Neeleman, the founder of JetBlue, and just assumed everything he touched would magically turn to gold. Neeleman’s first success in the airline industry came when he co-founded Morris Air and ultimately sold it to Southwest Airlines (LUV) in 1993. He left JetBlue in 2008 and has since started two more airlines; Azul and Breeze Airways.

Getting back to my investment in JBLU. I must have bought it in the early 2000s not long after the company went public. I don’t know the specific trade price for sure, but I believe I bought it somewhere around a split adjusted price of $16. Good thing I sold it not more than a year or two later as I would have been 10+ years to recover my original investment and if I held all the way to today I would be down on my trade.

JBLU would be the first and last time I ever owned an airline stock.

Turning Billionaires Into Millionaires

There’s really nothing to it. Start as a billionaire and then buy an airline.

– Richard Branson on how to become a Millionaire.

Warren Buffett has long been critical of investing in the airlines and highlighted Richard Branson’s quote in his 1996 letter to shareholders of Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B). Too bad he couldn’t heed is own advice as his most recent investment in the industry ended in failure with Berkshire completely selling out of all of its positions in the airlines in the spring of 2020 shortly after the pandemic began.

So if you are a billionaire like Buffett or Branson you probably aren’t reading this article right now. It’s more likely the case that you are working your way to your first million or two and evaluating how a thematic ETF like the U.S. Global Jets ETF (JETS) or any investment in an airline can help get you there.

Buffett made his investment in the “Big 4” U.S. airlines in late 2016. They have since combined to average a total return of -31.13% in the last 5 years. Yes, the pandemic was a negative catalyst for the industry during this period, but it still shows how volatile the airlines can be.

Now Buffett’s investment premise wasn’t necessarily wrong in 2016. He had suggested that the airline consolidation of the late 2000s and early 2010s was leading to more seats being filled, stable prices, and the airlines were capable of reliable buybacks. He was right for at least a short period of time until the pandemic changed the game completely.

As we emerge from the pandemic the airline game continues to evolve. Reopening should help improve load factors, but fuel prices are rising quickly. Consolidation is back on the horizon with Spirit Airlines (SAVE) and Frontier Group (ULCC) recently announcing their intention to merge and create the fifth-largest airline in the U.S. Fleet renewal programs have both been accelerated and slowed due to the pandemic changing the pace of capital expenditures. And pilot retirements that were moved forward early in the pandemic are now leading to a void that needs to be filled at some airlines as demand for travel returns.

The near-term reward for skill in the airline business is simply survival, not prosperity.

Warren Buffett – 1992 Letter to Berkshire Shareholders

Airlines Should Be Traded

All of the negative history aside, I don’t want to overlook the fact that individual airlines can make for a good trade at times and the use of a thematic ETF, like JETS, can have its merits when the opportunity presents.

There are 5 things that should be considered when timing a thematic trade in the airlines using JETS as a proxy.

1. The Price of Oil on a Macro Level – So we will get the obvious one out of the way. Generally, high oil prices are bad for airlines, especially when they are rising fast and outpacing the airlines’ ability to hedge. Southwest Airlines is famous for making the most of hedging. At least until the price of oil drops so much, as it did in late 2014-2015, and there is actually a cost to taking the hedges off.
2. Demand for Travel – Another easy one, but we should always be analyzing what is going on in the world that may positively or negatively impact travel demand. The pandemic is an easy example, but as we hopefully return to more normal times investors should learn some basic signs of how airlines indicate that they are structured for growth. This includes increasing fleet size via new orders or postponed retirements, Opening or expanding new focus cities/hubs, and establishing new route without sacrificing the existing network.
3. Profitability – When the airlines are profitable they typically engage in share repurchase programs and/or issue a dividend. These programs get cut pretty quickly when they are not profitable. Southwest had long been the bell cow for such activity and there is a strong assumption that they will be the first to reinstate the dividend if/when the time comes.
4. Capital Flows – The Airline industry is an extremely capital intensive business. They tend to go through periods of significant capital expenditures as they keep their fleets current. Some manage this better than others, but investors should always have a finger on the pulse for which airlines might be needing to spend more on new aircraft during a given period of time. Delta Air Lines (DAL) managed this process well post merger with Northwest as they elected to lease older Boeing 717s from Southwest (post AirTran merger) to replace the DC-9s they inherited from Northwest and buying used MD-80s to supplement the needs of their fleet.
5. Consolidation – Profitability really took off for the airlines around 2014 after the last cycle of mega-mergers and with the fall in oil prices. Periods of consolidation can be good for the investor assuming you bet on the right horse. If the merger of Spirit and Frontier is allowed to go through, we may be entering a period of further consolidation.

There is no way around the fact that the airline industry is a complex and very complicated business. It always seems like the needle is moving and it is very difficult to judge when the music might stop. As such, the airlines make for better trades than long-term investments.

JETS in a Holding Pattern

On the positive side of things, JETS has actually performed well recently given the negative pressure on the market. JETS is up a little over 3% in the last month all while the S&P 500 has fallen by more than -2% in the last month.

This seems to indicate that the reopening story is weighing heavier on the sector than the rising price in oil. Also keep in mind that most of the gains in JETS have come in the last two weeks after the merger announcement for Spirit and Frontier was made. I would keep an eye on the federal review process for the merger and this could have a broader impact on JETS in 2022 should the current administration not have the appetite.

Getting back to the reopening story, there is no doubt that demand for travel should be significantly higher in the remainder of 2022 and the airlines should see positive earnings growth. JETS was trading close to $25 prior to the Omicron variant and near $28 prior to the downturn associated with the Delta variant. Taking all other factors out of play, that would imply a 10-20% upside in the price on the back of positive sentiment related to travel demand.

However, we know that inflation pressure, the potential for conflict in Eastern Europe, and the price of oil may work against JETS in the near-term. I also haven’t even accounted for the expense ratio of 0.60% for the ETF (relatively high) or the weighting of the individual components. I will dive further into this as I begin to analyze each airline individually in this series, but having the Big 4 airlines equal weighted at ~10% each for a total of 40% of the ETF has its limitations.

The worst, at least in terms of this pandemic era cycle, should hopefully be behind the industry. All of the Big 4 exceeded estimates in this most recent round of earnings and analysts are forecasting revenue to be at or greater than 2019 levels. It would seem that there is only upward momentum from here, but I think the macro pressures in the overall market are too great at this time and I have a hold rating on JETS.

Summary

The opportunity should come to trade JETS in 2022 and I would look closer to the release of Q1 earnings later this spring to time a trade. This timing should allow for a more complete picture on oil prices, inflation, rising interest rates, geopolitical tensions, and an overall market that is running towards safety.