- The U.S. Global Jets ETF has sold off more sharply than the rest of the market.
- The impact of the coronavirus outbreak will last well beyond the next few earnings reports.
- Airlines will need to engage in aggressive price competition to convince customers to return.
- A second wave of the virus is likely, and it will be especially problematic for airlines.
- There are likely to be additional negative surprises for airline stocks.
The coronavirus outbreak is proving to be devastating for airlines. The airline industry, best represented by the U.S. Global Jets ETF (NYSEARCA:JETS), has been hit harder than the broader market and so far has failed to bounce back at all.
Source: Thomson Reuters Eikon
JETS is now 27% off its 52-week high. Is this an opportunity to "buy the dip" and bet on a recovery? Unfortunately, it looks like the pain is just beginning for airlines. The coronavirus outbreak is likely to have lingering effects on the industry. Given the capital-intensive nature of running an airline, the industry lacks the agility to respond. If there is a second wave of cases like there was with prior pandemics, it will be especially problematic for airlines.
Also note that broader transportation ETFs such as the iShares Transportation Average (IYT) and the SPDR S&P Transportation ETF (XTN) are vulnerable for similar reasons. However, in this article, I will hone in on the impact on airlines. JETS has a relatively concentrated portfolio, with 89% of its assets in airlines and the top 4 holdings accounting for 47% of total assets.
JETS Balance Sheets
The average airline has net debt/LTM EBITDA over 6 according to Thomson Reuters. Southwest Airlines (LUV) is a rare example of an airline with more cash than debt. In contrast, American Airlines (AAL), one of JETS' largest holdings is more sensitive to disruption because it has net debt/EBITDA of 13.68. Delta Air Lines (DAL), United Airlines (UAL) both have leverage slightly below industry average. A sharp dropoff in passengers will cause a spike in net debt/EBITDA for the entire airline industry. Many airlines will be forced to focus on paying down debt and have limited ability to operate strategically in a crisis.
Delta Air Lines
Source: Thomson Reuters EIKON
Expectations for airlines were high going into the start of 2020, with many airlines analyst expectations and raising guidance in late 2019. However, this has sharply reversed.
AAL, DAL, and UAL are all heavily impacted by the virus outbreak. They all suspended flights to China at the end of January. They recently announced the suspensions of more flights as well. UAL has suspended earnings guidance. The departure of Delta's CFO seems to be good timing. None of the locations that LUV serves is subject to travel restrictions right now, but air travel in the US is dropping off as well.
Note that the crash in JETS stock price last week (along with UAL's earlier suspension of guidance) occurred before the news report over the weekend that Amazon (AMZN) and other companies were curtailing domestic travel as well as international travel. Expectations clearly have further to drop, and that will impact stock prices.
The Second Wave Will Hit Airlines Extra Hard
Based on prior epidemics, it is likely there will be two waves of outbreaks. When the first wave subsides, people will start to travel a bit more, kids will return to school, and government health officials will relax vigilance. However, this leads to the second wave of the disease breaking out.
For example, the Spanish Flu epidemic, which is the most severe pandemic in modern history, had three waves: Spring 1918, Fall 1918, and Winter 1919. The second wave ended up being far worse than the first. Most of the deaths in the Spanish Flu epidemic occurred during the second wave. By the end of the third wave, one-third of the world's population had been infected.
This chart shows how the death rate changed for each of the three waves of the Spanish Flu Epidemic.
Similarly, 2009 H1N1 outbreak also had two waves, ultimately impacting 16% of humanity.
Why does this matter for the airline industry? First of all, it means that this won't just impact one or two quarters of earnings. In between the first and second wave, airlines will need to offer aggressive discounts to get people flying again. Aggressive price competition has historically been a huge problem for the airline industry. If the third wave hits, then they will return again to disaster mode. While the 2009 H1N1 outbreak occurred as markets were recovering from the global financial crisis, the coronavirus outbreak started at a time of record high valuations. The market is now much more sensitive to declining expectations.
Additionally, second wave will extend the time that this coronavirus stays in the public consciousness and increase the probability that it causes a permanent change in office work culture. The longer this goes on, the more companies will build processes and budgets that are heavy on teleconferencing/work at home, and light on travel.
Finally, a second wave will exacerbate the decline in public trust, leading to further turmoil in markets.
According to a report from the Global Health Security Index:
National health security is fundamentally weak around the world. No country is fully prepared for epidemics or pandemics, and every country has important gaps to address.
An aggressive stimulus is unlikely to convince people to fly if they are concerned for their safety and don't trust what the government is telling them about the coronavirus. This will be especially bad for airlines needing to raise capital or roll over debt.
Airlines will eventually become the ultimate contrarian bet on recovery. However, I'm not comfortable buying yet. There are likely additional negative surprises coming for the industry.
This article was written by
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