ETF Expert Corner

U.S. Global Investors CEO Frank Holmes Spotlights Jets ETF

August 9th, 2016 by ETF Store Staff

Frank Holmes, CEO of U.S. Global Investors, spotlights the U.S. Global Jets ETF (JETS) and goes in-depth on the airline industry.



Transcript

You can listen to our interview with Frank Holmes by using the above media player or enjoy a full transcription of the interview below.

Nate Geraci: The ETF we're spotlighting this week is the US Global Jets ETF. The ticker is JETS one of the better ticker symbols you're going to find. Joining us via phone from San Antonio to discuss this ETF is Frank Holmes, CEO of US Global Investors. Frank, we are thrilled to have you back on the program. Thank you for joining us today.

Frank Holmes: It's great to be here.

Nate Geraci: Frank, you joined us a little over a year ago to spotlight this ETF, not too long after it initially launched. First, just tell us what the past year has been like. This ETF now has close to $45 million invested in it. I know it has garnered a lot of media attention. I now see it used as a proxy for how airline stocks as a whole are performing. How pleased are you with the progress of this ETF so far?

Frank Holmes: I'm very very pleased with the reputation it's been able to attract as a proxy for the industry. It's very liquid. It has stock you can put some calls on it. You can do cover writing against it. Not many ETFs get launched, all of a sudden have this immense liquidity. We have seen investors come from Europe and Asia, in addition to Canada, and predominantly the US, but from other jurisdictions of the world to use that as a proxy for the airline industry.

Nate Geraci: Frank, for our listeners who aren't familiar with the JETS ETF explain to us exactly what this ETF holds. How many stocks are there? How are they selected and how often are these holdings re-balanced?

Frank Holmes: They're re-balanced every quarter. It's a dynamic ruled based system of thinking, and using factors, which we've done 3,000 hours of regression analysis of looking in up cycles and down cycles. If you recall, ten years ago most of this industry in the US, 70% was in bankruptcy. How good were these factors in functioning, and picking stocks, and sifting, and sorting? These five factors did exceptionally well and that's why we picked them. Every quarter stocks get screened that they qualify for these five factors. Such as revenue per passenger, what they call comport metric, looking for the most important cash return in invested capital. Looking at debt to equity ratios. These are all significant factors that give you out performance greater than just by market cap. What we did do with JETS which is unique at Global is that 80% are US companies, 20% are global. In those global companies not one airline is more than 1%. Therefore, the volatility of currencies, it get mitigated by having this 1% waiting. Two, when we look at the 80% being America, it's dominated by the four big horsemen and that is United, Delta, American, and Southwest Airlines, in particular, as the true work horses of carrying people across America. In fact, 2 million people a day are flying in America.

Nate Geraci: Frank, this ETF not only holds airlines but it also holds aircraft manufacturers, and airport terminal services, correct?

Frank Holmes: That's correct and when you leave the US you recognize that airports are public. The Beijing airport is public. Thailand it's public. In Mexico, many of the resorts you travel to, they're public. I know the one in Toronto is private equity. In the US they're all owned by the government. You do get this opportunity and these airports are basically toll gate operators and they have tags of 15% a year growth rates. They become an important part but the other significant factor is looking at Boeing. Boeing and Airbus that make these jets as long as they have high cash flow returns on invest to capitol, they can qualify. At times we've seen where Boeing is in and Boeing is out, and Airbus is in, Airbus is out. Boeing's been in there more often than Airbus.

Nate Geraci: I'm curious historically, when you look at aircraft manufacturers like Boeing or Airbus or General Dynamics, how closely do these stocks move with actual airline stocks? Do these typically move in lockstep or is there some divergence here?

Frank Holmes: There's a strong pattern that is more than 80%, when you do what's called correlation analysis, but it's time series, so you just don't say, "Give ten years," and try to plot a linear line. Because it's not going to happen. When you look at the largest airlines and Boeing as inertia goes, how often do they correlate over 20 days and 60 days is a more important factor. They do have a good correlation with the health of the industry and the health of the stock market. They're not as tied to fuel, so Boeing is not as tagged so much if oil prices rise. It can have a bigger impact on the cash flow of an airline. Boeing could still go ahead now they've become more fuel efficient jets so this is an opportunity up sale and that's why Boeing has a ten year backlog.

Nate Geraci: What about international airlines? As you mentioned this ETF does hold foreign airlines such as Air China and Lufthansa. Do you see diversification benefits here as well or does the global airline industry tend to move fairly closely together?

Frank Holmes: It moves with the global economy. It's an important factor for global economy. What we're seeing is that the travel in Asia is much stronger than Europe with the scare of the Belgium Airport in Brussels. Those factors will hurt European travel. Paris is feeling the difficulty with the terrorist scares, etc. Whereas Asia is booming. You see the major airlines, Delta and United saying that they increased their number of flights and your options to fly to Asia. We’re also seeing that Chinese tourism is becoming a significant factor. In fact, the Chinese as a whole, it gets lost in a billion four people but they have over 100 million middle class people and the ones, just like America, has dominated global travel and for tourism the Chinese last year surpassed. The 93 million tourist middle class Americans we have, the Chinese have well over 100 million and we're seeing Thailand, the number one tourism is Chinese. Indonesia's just been surpassed, Singapore, etc.

Nate Geraci: Again, we're visiting with Frank Holmes, CEO US Global Investors. We're spotlighting the US Global Jets ETF. Well, Frank, let’s talk about the airline industry in general. If you recall when you joined us on the show last year I brought up the fact that the business model for the airline industry has changed quite a bit over the past decade or so. It used to be airlines made money primarily from ticket purchases. Now they're all sorts of revenue streams. You have baggage fees, Wi-Fi, seat upgrades, early check in fees. How has the business of airlines changed over the years?

Frank Holmes: That's a great observation and that is two things that are really significant. It's because they had to survive. As I mentioned, going back not even five years ago the majority of the airlines were flying people around in bankruptcy proceedings. What they did was took away inches from the seat so they could put more seats per flight, so they could get more revenue per flight. Cancellation, if you want to switch your ticket it's a cancellation fee. All these fees have grown to from 5 billion, to 10 billion, to 20 billion. It's now estimated to be 40 billion a year of additional cash flow coming into the airline industry. That's a key factor. Another one is there's no options when they undercut each other. A lot of these mergers they cancel roots but they cannot go ahead and expand where they're going to say, "We're going to slash the cost of your ticket because we're going to have ten more options to fly from LA to New York City." It's not going to happen. A big reason why is there's not enough pilots.

Nate Geraci: Well, Frank, going back to the ancillary fees. What about credit card deals? I think some people may be surprised to learn an airline such as American, they can make substantial income from their credit card deals with Citi Group and Barclay's. How important is that revenue stream?

Frank Holmes: It's another great observation. It's much bigger than what anyone ever expected. We're talking about $100 million a month. It's a remarkable number when you take a look at the recent transaction that American Airlines announced for the next three years. $1.55 billion of additional cash flow for them. In this biz basically got absorbed by their 30 thousand employees with big salary increases and bonuses. It's one way for them to be able to keep the happy employees.

Nate Geraci: Again, we're vising with Frank Holmes, CEO of US Global Investors. We're spotlighting the US Global Jets ETF. Frank, certainly ancillary fees have helped with airline profits. I saw in June the International Air Transport Association announced they expect 2016 airline total net profits to reach 39.4 Billion which would mark the fifth straight year of profit growth in the airline industries. You touched on some of these but what have been some of the key factors contributing to the growing profitability?

Frank Holmes: I think one has been less options to fly so they give the airlines supply pricing power. The people are going to fly every day in America. 2 million people have got to fly. If there's less options for you to fly between cities then you'll fly any because you're doing business. Your price ticket goes up. That was a key factor, then on each of those flights adding more seats. That was another key factor and then another part that gets missed is that the low interest rates. Remember that the airlines lease a lot of these planes. With low interest rates now and refunding and refinancing it's been a huge cash flow swing for the industry.

Nate Geraci: What about just the size of the planes? It seems like planes are getting bigger but I have less leg room whenever I fly anywhere. What role does that play just in terms of efficiency in getting passengers on the plane?

Frank Holmes: Once again, that's a great observation. They basically took away inches per seat. Then they turn around and give them back to you but you have to pay a premium for those. If you want premium economy you went from having 34 inches between the seats down to 30 inches. If you go back and pay a premium, you can get back to 32 inches. They have been able to go back and reconfigure the planes but for simple numbers, they've basically gone from 150 seats per flight to 165. You added 15 extra seats which is basically a 10% growth in the number of seats per plane and that has been a wonderful addition revenue. Also, they've been carrying more cargo. They start charging per bag, so they can make a trade off. I can make more money charging cargo unless if I'm not going to take the cargo I have to charge for that baggage. They're making so much more money in the baggage. What's more important to me as a consumer is they put a lot of money into better technology for lost baggage. That makes a customer happy. If the flight is delayed because of Mother Nature, bad weather, etc. it's frustrating. If it's because they lost my baggage, and now I'm stuck, and they've got other problems of incompetence, whatever, now you get angry. That's what's so important, lost baggage really made people angry. They've alleviated that and not only do they make me happier they're saving themselves estimated at over 10 billion a year for the industry.

Nate Geraci: The other thing I'm curious about, when you look at airlines profitability, is the role of cheap oil. Of course, we've seen the price of oil come down over the past year and a half or so. Can you give us an idea as to the role the price of oil plays in airline profitability? How big of a cost input is fuel for air carriers?

Frank Holmes: It's been estimated that the total expense is gone from 27.5% down to about 20%. Close to about 8% saving over all in their cost structure. So it's free cash flow.

Conor Kelly: Frank, this is Conor Kelly. I want to go back to the point that you mentioned with the pilot shortage. I've read a bit about this recently and how, with the expected growth of travel especially like you said in Asia, the shortage of pilots is a real concern. How does the airline industry get over this? How does it adjust to the fact that more and more people are going expect to be flying and they're aren't enough pilots to fly the planes around?

Frank Holmes: I think it's a very big revelation to me when I was creating this ETF, of discovering this is a big factor. There was a tragic accident and congress changed the laws and basically thinking like Malcolm Gladwell the 10,000 hours, made the determination that pilots have to have at least 3,500 hours of task knowledge experience. They said, "Don't worry, we'll get them from the Air Force." Well, more and more kids no longer fly jets in the Air Force. They fly drones. That immediately created a shortage and they scrambled and said, "We have forced retirement at the age of 60" and then they said, "Well we have to raise that to 65." Japan, I think, took it to 67. What is positive is they found that the pilots are much healthier than they were 30 years ago. They're more concerned about their weight, and they work out, etc. We do have healthier pilots. Having not done that we would have lost 18,000 flights a day, would have been canceled. I think that the idea of training more, paying young pilots more money, put them through simulation flying at an earlier stage in their career path, is going to be important. Paying people more because these young pilots were making $36,000 a year. It was ridiculous. I think there's some really positive benefits from it.

Nate Geraci: As we look at the overall health of the airline industry right now, there have been several factors recently causing some concern. There's been some concern over what the so called Brexit might have on travel demand, especially in Europe. As you mentioned earlier, terrorist attacks. We have the attack on Brussels Airport and we know terrorism is certainly a concern for travelers. Give us your overall outlook on the airline industry right now.

Frank Holmes: I think Brexit was way overdone. It created a great buying opportunity. Ryanair just announced phenomenal numbers, phenomenal. It's Ireland so it doesn't get caught up with that turmoil. EasyJet was also put in the penalty box and declined like Ryan. I think that a lot of it is just noise. Basically, when you dig down and look at Brexit it reminds you of 1776. Taxation and regulation without representation is a protest. As it took place in America against the British and the British were protesting against the EU, that they're suffocating with the regulations and indirect taxation, and making them non-competitive. I think that, low and behold, that it will resolve itself. I think that you're going to see that the Ryanair’s and EasyJet’s were great buying opportunities. Now, the bigger threat is always the psychology of ISIS treats or it doesn't matter. Any type of a terrorist attack does psychologically dent, right away people cancel their flights. They'll cancel them domestically, they'll cancel them globally. When the Orlando shooting took place, the tragic event in Florida, immediately the rhetoric was "Gun laws, gun laws." That frightened people from flying. When it came out this person was a follower of ISIS immediately flights got canceled, you saw tickets get weak. All the airlines use this called yield management and they price based on bookings. It's very dynamic process. Immediately, President Obama came out that we're going to deal with ISIS, we're going to attack etc., etc. You saw all of a sudden, confidence come back. It's come out recently that Paris is having great difficulty with tourism dropping dramatically. That's much more significant as an impact.

Nate Geraci: What do you see as the one or two biggest positive catalysts for the industry moving forward? Is it this emergence of the global middle class in places like India and China? What's going to drive the airline industry moving forward?

Frank Holmes: I think that management is not going to go and spoil their returns on invested capital like they did before by undercutting each other for market share. I think you're seeing unprecedented buying back stock and increasing dividends. You read American Airlines, you read that last year the airline mystery increased their dividends by close to 100%. They have been buying back billions of dollars in stock. This never happened before. I think that this is a matter of time that they start going to a re-rating because you can buy this industry less than six times earnings and the S&P is trading closer to 18 times earnings. Transports, trains, and trucks are trading more like 15 to 18 times earnings. This is an inexpensive way to play the transport sector in the overall economy. What we see that every time the GDP numbers start to pick up global, then Global PMI, purchasing manufacturing index, which is a reflection of Global growth, when they turn positive the airline industry starts to climb. The big thing we need now is global growth, confidence, and then we'll have a re-rating in the sector.

Nate Geraci: All right Frank, we have about two minutes left and I want to ask you a question that I've asked, I think each of our guests over the past two months or so. It has to do with ETF proliferation. I'm not sure if you saw the comments from Vanguard CEO, Bill McNabb. This is a couple months ago where he said, "ETF proliferation has gotten out of hand." We talked on the show about how right now there's 1,900 plus ETFs but there's over 8,000 mutual funds and 24,000 mutual funds, when you consider all the share classes. We think, to a certain degree, this concern is a bit misguided. The question I would ask to you, some people might say that the Jets ETF this covers a more narrow segment. I would make the argument that people are still investing in the individual stocks that this ETF holds. I would much rather somebody make a more diversified play investing in the airline industry. I'm just curious, what are your thoughts on this discussion surrounding ETF proliferation? Where do you stand on that?

Frank Holmes: There's a big push by the regulatory world and general media on expenses, expenses, expenses. Just that product is a delivery product to the public. It's a lot less expensive. There's so many reasons for insurance, accounting, etc. The entry are lore and if you go to set up a mutual fund the costs are much higher, the maintenance and monitoring costs are so much higher. The regulatory burden is much greater than the ETF space. Then if you say it's not going to work you want to shut down a mutual fund, it's very costly. It's like reclamation for a mining deposit. Whereas an ETF it's a simple economic cost, and it's well defined, and it's liquidated. I think that they're the factors that make the product so interesting. The other part is what's called three way traffic which mutual funds can't offer. When I was launching JETS and what I noticed is that there is these hedge funds that say, "I love JetBlue but I don't like the industry. I want to go long something I want to go short. There's not airline products out there which I can go short." Another person says that, "I can't stand American Airlines I want to go short that but I don't want to get whipsawed in the industry. I don't want to make a call between two different companies, JetBlue vs. American or Southwest. I'll go long the EFT and I'll short American." You can't get that in mutual funds like you can get in ETFs. That creates a lot of liquidity around that particular type of product. That in addition to someone saying you know what I'm a carp investor and this industry is so inexpensive relative to the rest of it. I just read in Barron’s it is the cheapest industry of the hundred industries that make up the S&P 500. I want to go where I can buy things at a great value. You have three types of traffic looking for these investments and I think that's why the ETF business has prospered. I think that smart beta, dynamic rules based thinking will also continue to grow.

Nate Geraci: Frank, we'll have to leave it there. Just tremendous insight today on both the airline industry and ETFs. Thank you so much for coming back on the program. We certainly appreciate your time today.

Frank Holmes: Thank you for the opportunity of sharing my thoughts on this industry.

Nate Geraci: Thank you. That was Frank Holmes, CEO of US Global Investors. You can learn more about the US Global Jets ETF by visiting usglobaletfs.com. That's usglobaletfs.com.