You won’t find many sectors of the stock market showing a loss for this year. Despite last month’s quick sell-off due to the Japanese Yen carry trade, all the major stock market indexes have gained ground this year.

However, one sector that has been left behind is the passenger airline industry. At the start of this week, the S&P 500 Passenger Airlines index was down 8% year-to-date.

Even worse, the index has fallen more than 42% over the past five years as shown in the chart below. That is primarily due to the outbreak of the coronavirus pandemic in 2020, which greatly reduced passenger traffic over the remainder of that year.

According to Transportation Security Administration (TSA) checkpoint data, more than 2.6 million passengers flew within the United States on June 30, 2019. One year later while the pandemic was surging out of control, that figure was nearly 80% lower.

By 2022, passenger airline traffic was back up to its historical norms. But by then the damage had been done. Many airlines were forced to take on debt and sell assets to avoid bankruptcy.

The financial overhang from that catastrophe persists to this day. The debt put on the books four years ago won’t mature anytime soon. And when it does, the airlines may have to refinance some of those loans at higher interest rates.

For that reason, Wall Street’s reluctance to embrace the airline sector is understandable. Especially when there are companies involved in artificial intelligence, robotics, and other technologies that are much sexier than flying people around in planes.

United Airlines

Eventually, airlines stocks will rebound. Most of them are valued at very low multiples to sales and earnings.

Case in point is United Airlines (NSDQ: UAL), which is currently valued at less than five times forward earnings. At the same time, the company is projected to grow its earnings per share (EPS) by 26% over the next five years.

As a result, the PEG (price/earnings-to-growth) ratio for UAL is a ridiculously low 0.18. That is less than one-fifth the 1.0 maximum that legendary mutual fund manager Peter Lynch felt was a fair price to pay for a growth stock.

Of course, nobody is accusing UAL of being a growth stock these days. In fact, when United Airlines released its fiscal 2024 Q2 results last month it included this ominous statement in the press release: “For nearly two years, the airline has been anticipating significant domestic capacity reductions recently announced by a variety of U.S. airlines this summer and mid-August is an inflection point, with published schedule changes showing an approximately 3 point decline in industry capacity growth rate.”

The company’s CEO, Scott Kirby, further noted, “United has long been preparing for the moment when industry wide domestic capacity would adjust – it’s now clear that inflection point is just 30 days away.” If Kirby’s estimate is accurate, the industry is passing through that inflection point right now.

Deep Value

I have never been a fan of the airline industry from an investment perspective. Airlines operate on narrow margins that can quickly be compressed by events beyond their control. That list includes severe weather, rising fuel prices, and the occasional global pandemic.

However, I believe now may be a good time to take a flier on the sector. Once the Fed starts cutting interest rates, Wall Street will be on the lookout for deep value stocks trading at low multiples to earnings.

One way to do that is to buy a call option on UAL. A call option appreciates in value when the price of the underlying security goes up.

At the start of this week while UAL was trading around $42, the call option that expires in January 2026 at the $40 strike price could be bought for $10. That makes the breakeven price on this trade $50, which is less than 20% above the current share price.

That may seem like a lot of ground to cover over the next 17 months. However, UAL traded above $57 just five weeks ago. If it can get back to that price by the time this option expires, the return on investment would be 70%.

To be sure, there is no assurance that the airline sector will turn around anytime soon. Even if it does, that does not necessarily mean that UAL will participate in that recovery.

The hardest time to invest in a sector is when nobody on Wall Street wants it. That is why airline stocks are so cheap right now. It is also why the potential gain on this trade is so high.

Read This Story: How to Beat Wall Street…Under All Investing Conditions

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