Making money in the airline business is challenging at the best of times — and this clearly isn’t the best of times.

To earn a good profit, airlines need high consumer demand and stable or falling oil prices. Neither condition applies in today’s market, nor is it clear when either or both will. Instead, half-empty planes and high, possibly rising, fuel costs are likely to squeeze margins further.

The root of the problem, says Patricia Fee, money manager at I.G. International Management Ltd. in Dublin, is that airlines are capital intensive and have a product that is difficult to differentiate. They have a tendency to expand during profitable periods, leading to excess capacity. That is followed by fare discounts and falling earnings. Few airlines earn their cost of capital, Fee says.

Another significant risk factor is unionization. Most U.S. and European airlines are heavily unionized and deal with a wide array of unions — pilots, flight attendants, maintenance personnel and so on — resulting in periodic strikes and constant pressure for higher wages. Unionization can also mean bulging costs associated with pensions and other benefits, which accumulate and have to be financed.

These factors make the sector generally unattractive to money managers, although, Fee admits, there can be trading opportunities. With stock prices down 50%, investors who buy in just before the economic recovery gets underway and oil prices move down could make a good profit.

Some money managers think that even now there are opportunities in the sector, mainly among low-cost airlines that are non-unionized; use newer, fuel-efficient aircraft; have strong balance sheets; and are likely to pick up market share as passengers take cheaper flights to save money.

Southwest Airlines Co. of Dallas pioneered the low-cost model of offering low fares and “no frills” service. But money managers aren’t as enthusiastic about it as they are about its imitators. They point out that Southwest is unionized and, with more than 500 aircraft flying throughout the U.S., has already exhausted most of its growth opportunities. The airline is trying to attract corporate business, but this initiative could be expensive, particularly if it begins flying into major airports, at which the landing rights are more expensive than at the secondary airports that it normally uses.

Imitators, on the other hand, are smaller and offer more opportunities for growth. These include Ryanair Holdings PLC of Dublin, which is well known for its cheap flights around Europe; Allegiant Travel Co. of Las Vegas, which specializes in flights between the U.S. Midwest and Las Vegas; and Copa Holdings SA of Panama City, which serves North, Central and South America and the Caribbean. All three companies have strong balance sheets and good growth prospects.

Here’s a closer look at all four companies:

> Allegiant Travel Co. Robert Stevenson, research analyst at Franklin Resources Inc. in San Mateo, Calif., is enthusiastic about the stock, the company’s business model and its strong balance sheet.

As with all airline stocks, its share price, at $25.73 on April 9, is down. (All numbers are in U.S. dollars unless noted otherwise.) But it is only 30% off its October high of $38.74, whereas most other airlines are down 50%. Says Stevenson: “Allegiant continues to hit the numbers the Street is looking for, which other companies aren’t.”

The company’s niche is direct flights to major resorts. Its biggest market is non-stop flights from cities in the U.S. Midwest to Las Vegas. Passengers do not have to go to a hub and change planes. And its prices are about half of those charged by regular airlines.

“It’s a better product at a better price,” says Stevenson. He expects revenue and earnings growth to average about 20% a year over the next three to five years, assuming fuel costs stabilize.

To keep costs down, Allegiant buys used planes for $5 million–$6 million (new planes are $25 million–$30 million) and finances them out of cash flow, resulting in little debt on its balance sheet. It’s one of the few airlines that earns its cost of capital.

Like most low-cost airlines, Allegiant charges for ancillary services such as baggage, seat assignment, food and drinks, as well as arranging hotels, rental cars and vacation packages. This brings in substantial and fast-rising revenue: $65 million, or 18%, of the $360.6 million in total revenue in fiscal and calendar 2007 vs $31.3 million, or 12.8%, of $243.4 million in 2006.

@page_break@Allegiant reported net income of $31.5 million in 2007, way up from $15.8 million in 2006. Cash flow after net change in non-cash working capital was $73.9 million in 2007 vs $34.7 million a year earlier. Long-term debt was $31.9 million as of Dec. 31.

Maurice Gallagher Jr., president and CEO, owns 20.3% of the 20.4 million shares outstanding and U.S. investment firm Par Investment Partners LP holds 27.1%.

> Copa Holdings Sa. Founded in 1947, Copa is a passenger-focused airline that flies around the Americas and the Caribbean. It also owns Columbia’s second-largest carrier, AeroRepública, and has a strategic alliance with Houston-based Continental Airlines Inc., which owns 10% of its 42.9 million shares.

The stock, which trades on the New York Stock Exchange, closed at $37.59 a share on April 9 vs a high of $73.33 in July. Banco UBS Pactual SA in Rio de Janeiro rates the airline a “buy” with a 12-month target price of $44. Its Feb. 21 report notes that Copa is “carrying robust top-line momentum into 2008.”

J.P. Morgan Securities Inc. in New York suggests overweighting the stock within the Americas airlines sector. It prefers Copa to TAM Airlines in Brazil because of Copa’s “superior profitability, supply/demand fundamentals and less head-to-head competition.”

Stevenson, too, picks Copa, noting that, like Allegiant and Ryanair, it earns its cost of capital. It recently revamped its entire aircraft fleet — all 30 planes are now three to five years old — and, as a result, has one of the newest and youngest fleets in the industry.

Copa gets low-cost financing through the Export-Import Bank of the United States, Stevenson says.

Copa also has a major edge in its location at the centre of the Americas. This makes it possible to fly people with one stop to many locations while competitors are forced to make stops en route. Panama’s airport is also at sea level, which means Copa is less affected by the weather delays that occur more frequently at airports above sea level.

Copa reported net income of $160.4 million in fiscal and calendar 2007, up from $133.8 million in 2006. Revenue was $1 billion vs $851.2 million year-over-year.

> Ryanair Holdings Plc. Everyone knows about Ryanair’s incredibly low prices. Started in 1985, it has been the most successful of the low-cost airlines, copying but enhancing Southwest’s model by offering and charging for many ancillary services and acting as a middleman, arranging for hotels, hostels, tours, car rentals and travel insurance.

The company did very well hedging oil prices as they rose, allowing it to keep fares low. But the benefits of the hedging are running out. That reality, together with the economic uncertainty resulting from the U.S. slowdown/recession and the global credit crunch, has made investors uneasy. The resulting selloff halved the stock price, which closed at 2.83 euros on April 9. A year earlier, it traded at more than six euros.

The London office of UBS Ltd. has rated Ryanair a “buy” with a 12-month price target of 5.50 euros a share. It is basing that on two assumptions: an average oil price of US$90 a barrel for Ryanair’s fiscal year ending Mar. 31, 2009, and moderate capacity growth. Ryanair’s capacity grew by about 20% in fiscal 2008 while capacity elsewhere in Europe and Britain has declined as a result of downsizing and consolidation. It’s only when capacity grows more than 25% that yields drop, UBS says.

For his part, Stevenson praises Ryanair for its “relentless focus on driving costs down; it has by far the lowest-cost business model in Europe,” he says. In addition, it is half the size of Southwest and operates in a market that is twice as big. The airline keeps the age of its fleet low by selling planes when they are five years old and buying new planes out of cash flow.

If there is a global recession and/or oil prices stay over US$100 a barrel, Stevenson says other airlines will be hurt more than Ryanair. He expects Ryanair to have “massive” gains in market share and be in an even more dominant position when the economy recovers.

Ryanair reported net income of 454.8 million euros for the nine months ended Dec. 31, 2007, up from 376.9 million euros in the same period a year earlier. Revenue was 2.1 billion euros vs 1.7 billion euros. Cash flow after changes in non-cash working balances was 441.5 million euros vs 554.9 million euros. Long-term debt as of Dec. 31 was 1.9 billion euros. There are 1.5 million shares outstanding.

> Southwest Airlines Co. UBS Securities LLC in New York and J.P. Morgan both rate the stock a “neutral.” UBS has a 12-month price target of $12.50 share, the same price at which the 752 million widely held shares closed on April 9; that was well below the $16.96 high this past August.

Southwest primarily offers direct flights, minimizing the need to develop traditional hubs and keeping customer stopovers to a minimum. The average age of its aircraft is 9.4 years, with 301 averaging only 4.2 years, while the other 219 planes average 16.7 years.

Southwest has the strongest oil-price hedging program in the industry, according to J.P. Morgan. It is hedged at 70% of supplies at $51 a barrel for 2008 and has hedges in place for 2009-12. Nevertheless, its average cost of fuel per gallon was $1.70 in 2007, vs $1.03 in 2005 and 72¢ in 2003. Fuel costs accounted for 28% of operating expenses in 2007 vs 14.9% in 2003.

To offset the squeeze on margins, the airline is moving to attract business travellers. It is participating in the Galileo global travel distribution system to make booking easy, providing assigned seating and improving the frequent flyer program. Southwest is also exploring international code-share alliances for customers travelling abroad. It doesn’t charge for a wide range of ancillary services.

A UBS survey of travel managers in July 2007 “suggests a willingness to fly Southwest” given these changes. But UBS also warns that building a corporate travel base will take time and requires discounts that were previously taboo.

Unlike most discount airlines, Southwest is heavily unionized, with 82% of its 34,378 employees spread among 10 unions. But the company is relatively young and has not built up large pension and benefit plan liabilities.

Southwest was fined $10 million in April by the U.S. Federal Aviation Administration for violations related to aircraft inspections and maintenance. (The FAA has been investigating other airlines aggressively for similar violations, abruptly grounding hundreds of U.S. flights in mid-April.)

Southwest reported net income of $34 million in the first quarter ended March 31, 2008, down from $93 million in the same period a year earlier. Revenue was $2.5 billion vs $2.2 billion. Cash flow after net change in non-cash working balances was $964 million vs $617 million. Long-term debt was $2.1 billion as of March 31. IE