Seeking Alpha

Industry Analysis: Airlines

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Includes: AAL, DAL, JETS, LUV, MYC, UAL
by: Mark Bern, CFA
Summary

Affects of the CV (Covid-19 or SARS-Cov2) pandemic so far and going forward.

Major Airline Comparisons Sustainable demand recovery not likely for another 3 years.

Potential gains from here not worth the short-term risks.

Impact of the Pandemic

In April of 2020 air passenger traffic fell by over 90% (see chart in next section) from February 2020 and year ago levels. By late May traffic had doubled giving investors reason for exuberance (irrational as it may be). Unfortunately, a double, in this case, is still 80% below where demand was just two months prior. Also, May is usually a better month for air travel demand than in the dead of winter, making the comparison even worse.

For further perspective, after the September 11, 2001 World Trade Center and Pentagon bombings using airliners, the airline industry suffered a drop in demand of almost 50% and it took several years to recover. An event that happened on one day took several years for travelers to overcome the collective fear of flying. The pandemic has been with us (in the U.S.) now for several months and may continue unabated for another year or more.

Airline stocks have fallen and subsequently rebounded, but many remain 40-60% below January levels. Since demand is beginning to improve some analysts and investors may believe that this could be a great time to pick up some shares at bargain prices. I do not share that view and will gladly explain why.

Major airlines are hemorrhaging cash and expect to continue to do so well into 2021. Profits may not return until 2023 or later. Some, like American Airlines (AAL), will probably file for bankruptcy protection once again. Others may follow that path. Delta Airlines (DAL) is burning through $50 million/day; United Continental (UAL) is burning $45 million/day. This is after major cost cutting efforts already.

But my biggest concern is that too many people believe that the worst of this pandemic is behind us. Again, I am not among the believers. I have done too much research on past pandemics to buy into the optimistic view. It is my belief that we are still in the first wave (not the beginning of the 2 nd wave as some news agencies are reporting). The increases of infections in several states is merely due to a resurgence allowed by those who are no longer practicing social distancing. This is still the first wave.

The southern hemisphere is now in the early innings of its first wave. The northern hemisphere will experience its second wave beginning in October and gaining in strength over the course of the winter. Each major pandemic that has not been controlled early (like in the current case) has come in 3-4 waves, with the second wave reeking the most havoc in terms of cases and deaths. That is because the first wave has to spread geographically from one point on the globe, spreading out across a country, then a continent, then to a few points on other continents and finally across each continent. In the second wave, the pandemic starts from everywhere at once having already infiltrated many of the human population centers around the globe.

Scientists and people of all walks of life (including politicians) are divided on whether or not weather has any effect on the virus. Generally, a coronavirus does not do as well during humid weather but thrives during cold dry weather. This is the case with the common cold which is also a form of coronavirus. My understanding is that the virus can remain airborne longer in dry air because, with less moisture in the air, there are less particles already airborne that it would combine with to add mass, so gravity does not pull it to the ground as quickly. Stated differently: more humidity leads to more combinations, more mass and faster descent; less humidity provides less to combine with and lower gravitational pull because the mass remains smaller for longer. Anyway, the longer the virus remains aloft the more easily it can spread because it can come into contact with more people passing through the area. That seems logical to me, but I cannot find the source where I first read it years ago.

If my assessment is correct (and I truly hope it is not) the recovery in airline traffic will be short-lived. Again, if I am right, by January 2021 fear will have captured the minds of would be travelers once again and it won’t matter whether governments allow airlines to fly or not; most people just won’t risk it. That fear could potentially take several years to subside.

I could be wrong, and we may find a way to contain the virus or it may just play out on its own, but assuming either to be true without validation is just gambling. There will be a time to buy the stock of the best run airlines but I, for one, believe that day is still in our future when the worst really is behind us.

Industry Overview

This first chart compares passenger traffic in 2020 to that of 2019.

In mid-April passenger traffic was down as much as 95% Y/O/Y (year over year). Passenger traffic remains very depressed and some of the business travel may never come back. Companies are learning that they can function just fine with virtual meetings generating significant cost savings. Many families will choose to travel by car when possible instead of flying, at least for the next few years. Bringing back demand to levels prior to the pandemic will be a slow, uneven process.

Airlines that accepted funds from the federal government under the CARES Act have some requirements that have been imposed upon them: the companies cannot fire employees until October 1, 2020 (the U.S. government is essentially paying the airlines’ employees to reduce unemployment temporarily) and airlines cannot pay dividends or buy back shares until successful repayment of loans has been achieved (no longer than 10 years) are among the major ones.

Some airline CEOs have already announced intentions to layoff 10s of thousands of unneeded employees beginning October 1. Capacity will remain a fraction of what it was prior to the pandemic. Planes will remain grounded or airlines will attempt to sell their excess planes. But who will buy the older gas guzzlers that the companies want to part with? Every airline in every country is experiencing the same problem. Most want to sell planes or upgrade to newer, more fuel-efficient planes. Where are the buyers going to come from? This is what airlines have done in the past, but the circumstances are very different this time. Every time before was much more temporary and often driven by financial problems that could be cleared up in bankruptcy because other air travel markets had not suffered and needed to add capacity. That is just not the case today.

My expectation is for a final bottom for airlines to come by Spring or Summer of 2021, after the 2 nd wave has done most of its damage.

Looking at a Few Examples

American Airlines(AAL) may be in the worst shape.

Source: Friedrich Global Research

American, which already has some $136 per share in Total Liabilities and only trades at $12.40 a share, announced the following:

American Airlines Group Inc. said Sunday it plans to raise $3.5 billion in new financing to boost its liquidity amid the coronavirus pandemic, which has severely curtailed air travel. In statements Sunday, the airline said it plans to raise $1.5 billion in senior secured notes due in 2025, will sell $750 million in shares and another $750 million in senior convertible notes due in 2025, and will enter a $500 million loan facility. Goldman Sachs, Citigroup, BofA Securities and JP Morgan will be acting as representatives for the underwriters.

Traffic is way down as can be seen in this graphic illustration from TSA (Transportation Security Authority).

Or,

Or, if you prefer a non-governmental source, here is a chart from Flight Tracker:

Risks Are Mounting

Either way, though airline traffic may have been rising for several weeks, with the increased number of Covid-19 cases occurring it is highly likely that air travel will at least level off, if not begin to decrease again in coming weeks. And the airlines are all in bad shape.

In the case of Delta Airlines (DAL), its recent earnings report tells the tale of misery facing the industry.

The company experienced a Y/O/Y drop in revenues of 88% and went from earnings of $1.4B in its 2019 Q2 to a loss of -$5.7B this last quarter, and EPS (earnings per share) fell from $2.21 to a loss of -$9.01 in the same periods. The revenues will climb some and the losses will narrow, but profits are probably a couple of years away.

The next step is for airlines to attempt to match capacity with demand (which will be a moving target), including not just flights but employees, airport services and the number of planes owned (or leased) to get operations closer to break even, reduce the bleeding and shore up balance sheets. The problem is that they will probably all continue to need to add more debt (increasing interest expenses and weakening balance sheets). Fixing the problems will be much more complicated and difficult than in the past as mentioned earlier. The final fix may require either more government bailouts, bankruptcy restructuring or both. That can’t be good for common stock investors as they will either be diluted by government ownership or wiped out by bankruptcies.

Friedrich is not very fond of any of the major airlines right now:

Source: Friedrich Global Research

Source: Friedrich Global Research

Each one has a Main Street Price of $0 because our estimated fair value is derived using FCF (free cash flow) and every airline is generating negative free cash flow (burning cash). Capacity and costs may be cut but the negative FCF is likely to continue for the next year or two, in my humble opinion.

Another way to look at the airline industry is via Stock Rover, another stock evaluation tool that I use. It uses a ranking system (higher being better) and allows one to compare a company to its peers:

Source: Stockrover.com

As you can see, DAL does not fair so well and AAL looks even worse. I have provided (with permission from Stock Rover) a full 8-page stock report from Stock Rover for DAL in an instablog here on SA primarily for my real-time followers. I intend to do something similar for leading companies in other industries as well. Each will include a peers analysis summary along with many other features included in these very detailed reports.

Conclusion

Airlines are not likely to recover quickly as some investors seem to expect. Normalcy will not return to the skies for several years as this pandemic will determine the course of our future, at least well into 2021. Comments from airline CEOs and executives support that assumption.

Even if a vaccine is granted approval by year-end 2020, producing 300+ million doses will take at least six months and the U.S. may not have the capacity domestically to get the job done in an acceptable timeframe. If a vaccine is developed here first but we need production to occur overseas, what country will allow us to not include vaccines for their population? The production and distribution process could get complicated and political (as is everything else), so I’m not holding my breath for an overnight miracle.

If investors want to wade into airlines for the potential future rally, I suggest that they wait for a more decisive bottom from which traffic improvements can be sustained longer term. Now, in my opinion, is not that time. The short to intermediate risk is still too high. And even when the time is right, we must always stick with the best of the best or risk being wiped out in bankruptcy proceedings. Of the majors, my favorite is Southwest (LUV). Of course, everything could change depending on how long the crisis lasts and how each management team navigates the travails ahead.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Additional disclosure: DISCLAIMER: This analysis is not advice to buy or sell this or any stock; it is just pointing out an objective observation of unique patterns that developed from our research. Factual material is obtained from sources believed to be reliable, but the poster is not responsible for any errors or omissions, or for the results of actions taken based on information contained herein. Nothing herein should be construed as an offer to buy or sell securities or to give individual investment advice.