Amazingly, the recent rally in United Airlines (NYSE:UAL) only brings the stock back up to levels from late 2015. In general, the airlines is seen in a better light now after strong results and new CEO Oscar Munoz gains momentum.
At around $56, the stock has a meager market value considering the cash generation in the last quarter alone. The recommendation was that United Airlines was set to soar back around the June and July lows, but the question now is whether the rally changes that thesis.
First and foremost, United Airlines generated a huge Q3 operating profit of $1.6 billion with net earnings of $1.0 billion. Note that the market cap is only at a minimal $18.0 billion while the smaller revenue based of Delta Air Lines (NYSE:DAL) is worth $31.0 billion.
For years now, Delta Air Lines had been the top operator in the sector, but the valuation multiple gap is rather large for the transportation industry. Up until recently, Delta traded at nearly double the P/S multiple with signs at the time that the gap could widen.
UAL PS Ratio (Forward) data by YCharts
Lately, United has started impressing the market. The quarterly results actually beat analyst estimates by a wide $0.23 showing how the airline has turned the corner. Wall Street rewards companies that can produce on forecasts, especially after United had a couple of quarterly reports to start the year that highly disappointed the market.
Capital Return Signals
A big part of the thesis that placed the airline on the buy list were the massive capital returns. The market viewed United as a struggling airline while the company itself was happily repurchasing shares. These signals are polar opposites and typically signals the market underestimates the turnaround under way.
For Q3, United Airlines spent $255 million on share buybacks for roughly 1.5% of the outstanding shares. This quarterly amount was solid, but it falls far below the levels of the last few quarters that includes the purchase of nearly 8.0% of the outstanding shares during Q1.
After such a big purchase during Q1, one needs to allow the company to pause on share buybacks before making any broad opinions on possibly a shift in the stock value. Since United actually continued on a 6% annual buyback pace during Q3, the signal is actually quite bullish.
A big key is the $2.0 billion remaining on the share repurchase plan. The airline would need to signal a willingness to start aggressively buying shares in the next few quarters before this capital return signal would turn bearish.
The key investor takeaway is that United Airlines is only trading back at more normal levels after the swoon during the Summer. Supported by capital returns and a low valuation, the stock appears poised to close some of the valuation gap with the leading airline.
Disclosure: I am/we are long UAL.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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