Are airline stocks ready for takeoff?

Over the last couple of years, the major carriers have seen their profits squeezed by a combination of elevated fuel prices and a reduction in business and leisure travel. Now, analysts say that improving revenue trends have left these stocks poised to benefit from a lift in the economy.

This week, the major carriers began reporting their fourth-quarter and full-year earnings, and although profits remained fairly weak, the data allude to a better picture on the horizon. On Thursday, Continental Airlines (CAL) reported a net loss for 2009, but the company posted net income of three cents a share for the fourth quarter, excluding special items. Passenger revenue for the quarter was down 9.5% from 2008, but Chief Executive Jeff Smisek said in a statement that the company predicts an increase in higher-yielding business travel.

Separately, Southwest Airlines reported Thursday turning a fourth-quarter profit of 10 cents a share (excluding special items), compared with a net loss for the fourth quarter of 2008. The company said passenger unit revenue grew 7.4% year-over-year in the fourth quarter.

And on Wednesday, shares of AMR, the holding company that owns American Airlines, jumped more than 5% after the carrier reported that the decline in passenger revenues had slowed.

The picture for the sector will become clearer next week. Delta Air Lines is scheduled to report earnings on Monday, United Airlines and AirTran on Wednesday, and US Airways Group and JetBlue plan to round out the week on Thursday. Delta, United and US Airways are expected to report narrower losses, compared with the fourth quarter of 2008, while analysts expect AirTran to swing to a profit and JetBlue to report a modestly higher profit.

Going forward, even modest economic growth of around 2% should spur a rebound in demand for airlines, says Helane Becker, managing director of Jesup & Lamont Securities Corporation, who covers the industry. Right now we re going into a period of time where the comparisons are very easy, and quite frankly, the stock prices should follow, she says.

Like most industries, the airlines owe part of their turnaround to a more efficient use of their resources. AMR Corporation reported its total available seat miles fell 4.9% year-over-year in the fourth quarter, boosting its load factor, or the percentage of its seats filled, to a record 81.1%. Other carriers have also worked to keep capacity low and load factors high, including Continental, whose December load factor was a record 83%, up 3.1% year-over-year. Delta, Southwest and US Airways also reported lower capacity for December, while JetBlue and AirTran Holdings reported increased capacity after adding new routes, but kept load factors in line with their peers.

Now, the question airlines face this year is how long they can keep their planes 80% full. AMR is projecting a further 2.8% capacity decrease in the first quarter, but a slight increase in capacity for the full upcoming year. With load factors throughout the industry already at about 80%, there s not much room for further increases, Becker says. Along with American Airlines, most carriers will likely begin adding capacity in the second half of the year, which could limit their ability to raise fares from recent aggressively discounted levels, she says.

Declines in per-passenger revenue have started to slow, and airlines could see double-digit gains in unit revenues, particularly with easy comparisons ahead in the second and third quarters, says Michael Derchin, an analyst at FTN Capital Markets who covers the sector. However, fuel prices continue to rise, you re going to need that to offset higher fuel prices, Derchin says. All airlines attempt to hedge against swings in fuel prices, but the best hedges these guys have is having the most fuel-efficient airplanes, and of the legacy carriers, American has the most aggressive fleet-replacement plans for the next couple of years, he says.

Legacy carriers ability to increase revenue per passenger in 2010 will depend in large part on the return of higher-paying business travelers. Typically, business travel picks up about six months after employment starts to pick up, says Basili Alukos, an analyst at Morningstar who covers the sector. If business travel rebounds as expected, carriers like JetBlue that cater more to leisure travelers could lag behind their peers, says Stephen O Hara, an analyst at Sidoti & Company, who covers JetBlue. If business travel comes back sharply, they ll lag; if it s a more muted recovery, they should be close to the head of the pack, O Hara says.