Anyone who travels is aware the major air carriers have gotten a bit greedy in recent years. Despite sluggish real wage growth and elevated unemployment levels, most airlines continue to whack customers with high fares and extra costs. Carriers are charging for upgraded seats, priority boarding, extra bags and food on the flight. But savvy investors don’t get mad, they get even. Market profits can still be had by investing in the top-performing companies.

After consolidated into a lesser number players during the aftermath of the credit crisis, the airline majors have been using their collective bargaining power to wring more cash from passengers, but investors are benefiting. Higher revenues for airlines are finally starting to translate into bigger airline profits and soaring share prices.

In over 25 years of investment management as a portfolio manager, I have generally taken a cautious approach towards investing directly in the major US airlines. The group rarely makes my basic cut for solid financial strength and consistent earnings progress. Moreover, the relatively low barriers to entry and high operating costs make it hard to find companies with a sustainable competitive advantage.

On the other hand, the sector’s choppy track record since being deregulated more than 30 years ago, often make these stocks look cheap. Furthermore, they are typically under-owned or outright avoided by risk-conscious investors. That may be for good reason, but the scenario frequently makes for sharp upward moves in the stocks when things finally go right.

My unease about the group was best framed by a former MBA school professor who preached that the airlines are perpetually challenged by high fixed costs, high variable costs, volatile oil prices and non-loyal, cost sensitive customers. Even at those times when circumstances finally get bright, the carriers like to engage in revenue crushing fare wars, squandering their fortunes in the best of times.

Indeed, this scenario has largely played out over the past few decades. Low price start-up carriers have repeatedly entered key markets crimping the profitability of entrenched companies burdened with high legacy costs. Increased competition and lower prices have squeezed profit margins in each down cycle leading to numerous bankruptcies and forced consolidations. Over the past three decades, 26 airlines have gone into bankruptcy, including a few of the larger carriers which have gone under more than once. Meanwhile, forced mergers in recent years include Delta/Northwest, United/Continental, and American/US Airways.

This said, a new trend appears to be emerging. Industry consolidation seems to have at long last begun to help improve revenue per passenger-mile and yield levels for most players. As well, capacity constraints have let to better load factors and improved pricing power. All in all, the industry finally seems to be creating a more rational pricing environment which has been generating decent profits.

Not only are the majors earning profits again but many are returning the cash back to shareholders. Recently, American Airlines Group and at United Continental Holdings, the parent company of United Airlines, announced stock buybacks of up to $1 billion. American Airlines, after emerging from bankruptcy again just declared its first dividend payment since 1980.

Professional investors have been taking notice. Value line, an independent research and publishing company in business for over 80 years, rates Air Transport as its top-ranked industry, scoring the sector at number one out of 100.

Hedge fund managers have become involved, too. Goldman Sachs’ list of the most widely held individual stock positions among hedge funds includes Delta Air Lines and American Airlines which both placed among the top 20 companies in this year’s survey.

Indeed, the stocks have been serving investors well. The Arca Global Airline index, a basket of airline stocks, is up 52.8 percent over the past year versus an increase of 21.1 percent for the S&P 500. The LOM Equity Growth Fund holds a position in Delta Air Lines which continues to score well on both our quantitative and qualitative models and has appreciated in price by about 80 percent in the past 12 months.

Besides the advance in airline companies, other players in the aerospace industry food chain are also benefiting from cyclical and secular tail winds. Boeing, the world’s largest airline manufacturer has easily exceeded profit estimates in each of the past four quarters. In the latest quarter, the company beat estimates by 22 percent and guided analysts’ higher by over five percent for this year’s earnings.

A major concern over Boeing stock and the rest of the industry is that profits may be peaking for this cycle. However, the jet maker sees an extended cycle this time around as a rapidly expanding emerging market middle class finds means to travel. Boeing stands by its latest forecast of a rise in commercial jet production of five percent annually over the next two decades.

Other companies we like in this space include General Electric, the largest manufacturer of wide-body jet engines and Honeywell, a market leader in avionics. Many precision parts are required to safely operate an aeroplane and avionics represents the critical technology behind aircraft cockpit controls. Both GE and Honeywell meet our criteria for shareholder-friendly capital allocation policies in addition to maintaining market leadership positions.

While the aerospace industry appears ripe for further progress, several headwinds do exist. Major risks include higher energy prices, a slowdown in emerging markets and geopolitical events which might keep travellers grounded. Investors must also be aware the industry still retains its cyclical underpinnings and a severe economic downturn could wipe out recent gains.

Notwithstanding the cyclical nature of the aerospace sector, we anticipate a strong secular trend in the years ahead. Investors can who climb on board can likely find both value and growth opportunities in select companies as part of a diversified portfolio.

Bryan Dooley, CFA, is a senior portfolio manager at LOM Asset Management Ltd in Bermuda. Please contact LOM at 441-292-5000 for further information.

This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority.