Should you buy Qantas Airways Limited or Virgin Australia Holdings Ltd? 

It’s hard to escape from the fact that oil prices have fallen dramatically recently, especially when the market volatility we are seeing has largely been credited to the ups and downs of the oil price.

But it’s not all bad news. Just as you and I have noticed a pleasant reduction in the price of petrol at our local Caltex Australia Limited (ASX: CTX) service stations, so too have airlines noticed it with the price of jet fuel.

Both Qantas Airways Limited (ASX: QAN) and Virgin Australia Holdings Ltd (ASX: VAH) have seen a remarkable reduction in operating costs thanks to a drop from $3.29 per gallon of jet fuel in January 2014, to $1.22 per gallon today. This has helped lift the operating profit margin for Qantas year over year from 6.5% to 14.8%, and for Virgin Australia it has gone from 3.8% to 6.8%.

Some analysts believe there is a chance that WTI oil will drop as low as US$25 a barrel in the near future if the global supply glut continues. A drop to this level would certainly provide a positive impact on the operating margins and bottom lines of both airlines.

Airlines traditionally have a tendency to trade at a low price-to-earnings ratio. With Virgin Australia trading at a forward price-to-earnings ratio of 22.9 it certainly does look expensive in comparison to Qantas which is trading at 6.7 times its forecast forward earnings. The return on equity of Qantas is also vastly superior to that of Virgin Australia. Currently the return on equity for Qantas is 20.4% and for Virgin Australia it is a lowly 0.3%.

This for me makes Qantas the better option for an investment today. With jet fuel at such low levels and Australia becoming an appealing tourist destination for consumers, I feel Qantas is better positioned to profit from it than Virgin Australia. I think the levels of profitability that Virgin Australia produces will have to improve greatly from where they are today to make it a worthy investment in the future.

While both stocks could potentially offer earnings growth in the future it is worth noting how quickly things can change in the airline industry.

Many readers that have been watching the markets in recent years will have seen the shares of Qantas rise like a phoenix from the flames after years of trading at beaten-down prices. Just over two years ago shares were trading at levels as low as 95 cents, but now find themselves some 300% higher. This rapid share price rise would not have occurred if oil prices had remained at high levels.

Foolish takeaway

I believe that Qantas could be considered a good short-term investment as it looks to be well positioned to capture the increase in tourism to Australia, as well as benefitting from the low oil prices. The forward price-to-earnings ratio it is trading at is incredibly low and offers much better value than Virgin Australia.

In the long term, the price of oil will most probably dictate the fortunes of both companies. It could theoretically increase just as quickly as it has decreased, so I feel investors should keep a close eye on its price and be wary of airlines over the long term.

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Motley Fool contributor James Mickleboro has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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