Airline investors hold their nerve despite falling share prices

Upbeat news from the recently formed International Airlines Group, which recently reported continued growth in passenger traffic and revenue, was over-shadowed by gloomy forecasts from the overall industry body. IATA reported that the positive measures being reported by the industry were based upon the optimistic outlook that marked the start of the year, but with business and consumer confidence back in decline, and high fuel prices and sluggish international trade, a weaker end to the year is expected. Investor reaction seems minimal with average short interest across the sector low at only 2% of total shares. We use securities lending flow to assess changing sentiment.

US Airlines are most shorted

The Bloomberg RV screen below shows that U.S. airlines account for 9 out of the top 10 global airlines with the greatest percentage of stock on loan. That said, all but United Continental Airlines have seen some decline in short interest over the past month. Many of the airlines in the screen have issued convertible bonds, which can inflate demand to borrow the shares as investors hedge their exposure to the bond by selling short the underlying equity. However, there seems to be an element of directional short selling in many of these names.

The share price of JetBlue Airways Corp is currently trading at almost half the annual highs recorded in November 2010, so it is not surprising to see that this stock is the most shorted in its industry, with 16% of total shares out on loan. However, this is down from the high of 28% observed in March, which in fact could be an indication of positive sentiment. Institutional investors who lend their stock also seem to share this view. Although they have only increased their total holdings marginally over the year, they are overweight the average for the sector and own a third of the company.

The movement of shares being borrowed in United Continental Holdings is highly volatile and closely tracks price, indicating a high level of convertible arbitrage. Outside of this, a degree of directional short selling activity is evident, which accounts for around 10% of total shares outstanding on loan. Institutional investors have also made little change to their holdings of 17% of total market cap’.

Europe

Unlike the U.S., European airline stocks are subject to contrasting sentiments. Share prices may be continuing their downward trajectory, but investor sentiment towards the key players: Air France -KLM and Deutsche Lufthansa AG are on opposite ends of the spectrum. Lufthansa sees low and flat short interest at less than 1%, and institutional ownership of funds who lend at 25%.

Air France-KLM is looking disappointingly bearish from all fronts. The airline is reported to be making wide ranging cuts from growth targets to capacity constraints. The French press have reported that the airline is looking for savings of EUR 700-800 million. This comes after a year of airlines having raised airfares several times to accommodate rising costs and also retrenchment of their businesses. Short interest has reached an 18 month high of 7% of total shares, and holdings of institutional investors have retreated to levels seen last year at 10% of total shares.

Demand to borrow the shares of International Consolidated Airlines stands at 3.49% of the company, but is primarily driven by arbitrage over the convertible bonds in issue.

Flat institutional ownership

From a securities lending point of view, the airline industry seems to have entered a period of stagnation. Institutional investment by funds who lend is broadly in line with the market average in the US at 20% of the sector’s market capitalization. What is interesting is that we have not witnessed much movement in institutional holdings despite the macro economic uncertainty.