| NEW YORK
NEW YORK Legg Mason Inc's (LM.N) Bill Miller sees a clearing in the inclement weather that's long dogged the airline industry.
Miller, known for his willingness to invest where few others dare, has taken a gleam to airline stocks -- just the latest contrarian bet by the man who beat the Standard & Poor's 500 Index for 15 years before taking a nose-dive in 2008.
To be clear, Miller does not expect a phenomenal new future for an industry that has been a nightmare for investors since commercial flying began in the 1920s. Good trades, but not good investments, he readily acknowledges.
"Airlines are probably the worst industry in the history of the world to actually to invest in," Miller said this week in an interview at the Reuters 2011 Investment Outlook Summit. "So we're not under any illusions that we're making a strong bet that airlines will now be a five- or 10-year investment."
Miller's thinking about the airline industry offers insight into his uncanny ability to find value others can't fathom.
Miller said that probably the most important factor in markets is a term called nonstationary, a word popular in academia for indicating things actually change.
The idea seems ordinary but is relevant for an investor when coupled with the notion that people fail to see an opportunity because they expect a situation to stay constant.
"When things have persisted for awhile, people believe they're going to persist forever," Miller said.
"Airlines have been a bad business for about 90 years, that's a pretty persistent pattern. They may still be bad, but there again, maybe they're not," he said.
The two big mergers in the U.S. airline industry, involving United Continental Holdings Inc (UAL.N) and Delta Air Lines Inc (DAL.N), and future consolidation, such as Southwest Airlines Co's (LUV.N) plans to buy AirTran Holdings Inc AAI.N, should boost the industry's pricing power.
Perhaps more importantly, executive bonuses at Delta and Southwest have recently been tied in part on the return on invested capital, Miller said.
"That will now motivate the management so they're going to think twice about buying some big airplane for $80 million if they can't get a return on it," he said.
Of course, airlines once again may prove to be a poor investment, yet the industry's share pricings are cheap, Miller said. UAL has a free cash flow yield of almost 30 percent and trades at about 5 1/2 times this year's earnings, he said.
Airlines are the single biggest industry in the Opportunity Fund (LMOPX.O), Miller's mid-cap fund. UAL, whose stock has doubled over the past 12 months, was added in the third quarter to Miller's flagship Value Trust fund (LMVTX.O).
A potential shift into large-cap stocks, a mainstay of Value Trust, would help Miller, whose fund this year has performed poorly after beating the larger market last year.
Large-caps are cheap relative to small-caps, which hit an all-time high on Thursday, according to the Wilshire U.S. Small-Cap Index .W5KSC.
Miller and new co-manager Sam Peters at his flagship Value Trust have been closely looking at the airline and automotive industries because they have been starved for capital and left for dead.
"Industries can reorient themselves and then cyclically come back and have an extended period where returns on invested capital and cash flows rebound very nicely," said Peters, who in May was named Miller's eventual successor.
"You almost have a little bit of a renaissance. Sometimes that's cyclical, sometimes you get very lucky, and it becomes secular," Peters said.
(Reporting by Herbert Lash;; Editing by Padraic Cassidy)