High-yield players see more good times ahead for airline sector issues even after impressive gains last week. They cite ratings stabilization, an improving economy and stronger-than-expected earnings announced by Delta Air Lines,Northwest Airlines and Continental Airlines, which through last Thursday accounted for 62.5% of market value in the high-yield air transport sector, according to Merrill Lynch. There is also the simple fact that investors are running out of other options. "In terms of yield, it's one of the last frontiers out there," says Dale Spencer, portfolio manager at Stamford, Conn.-based Aladdin Capital Management. Through last Thursday, air transport issues offered a 13.82% yield, versus 8.13% for the junk market as a whole, according to Merrill.
Hedge funds in particular have been flocking to airlines, as they have received a flood of new money this year, and look to deliver on promises of double digit returns, says Bill Mastoris, analyst at BNY Capital Markets. Mastoris says "B" and "C" tranches of EETC issues, which are backed by aircraft, can yield even more than unsecured issues in some cases, offering excellent compensation for their relative illiquidity. He says investors have rightly favored short-dated issues maturing in 2004 and 2005, as they are more likely to be paid. In a recent research report, he recommended Northwest's 7 5/8% notes of '05. He says the airline is committed to paying the interest and principal on the bonds, even though he expects Northwest to give investors an opportunity to exchange them for a longer-dated issue.
Aladdin however, has been buying longer dated issues from Continental such as the "B" tranches issued in the late 90s and early 2000, which were bid at 78 last Thursday. Spencer argues that the airline will not default, and points to Standard & Poor's recent decision to move the outlook on the carrier from negative to stable. "Once you get stabilization in the ratings, that allows traditional investors to take a hard look at the asset class. That adds stability, and stability creates more stability," he says.
Indeed, high-yield mutual funds are starting to take an interest. "It's hard to imagine hotels being filled and seeing better bookings without airlines seeing some of the benefits," says Tom LaPointe, portfolio manager at Columbia Management Group, which recently purchased issues from Delta and Northwest. Another Boston portfolio manager says his firm owns some Delta issues, and is looking at expanding its holdings to other carriers, as the performance of Northwest and Continental suggest that the industry as a whole is improving.