In spite of the massive run-up in US stocks over the past couple of months (the S&P 500, unbelievably is down only a hair now in 2020), there is one sector that has declined significantly more: the airlines. Companies like Delta, United, American and SouthWest (known collectively as “The Big 4”, controlling 80% of US air travel) along with their more regional counterparts Alaska, JetBlue, SpiritAir, etc. have seen their common share prices absolutely crushed by 50-70% over the past few months.
The precipitous decline in passenger air travel demand since the outbreak of COVID-19 has seen airline revenues dry up almost overnight. Over the last couple months the industry has done what it can to cut costs……canceling tens of thousands of flights, grounding numerous planes and cutting schedules. Revenues are expected to fall by 90% year-over-year, where it seems that no amount of cutting is enough to stem the cash bleed. Airlines have lost billions in the first quarter and are expected to lose even more in the second.
As such, the Federal government stepped in recently with $50 billion in liquidity ($25 billion in cash grants and $25 billion in loans) through the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). These funds are designed to help the airlines get through the rest of the summer. The airlines have also traded stock warrants (a kind of long-term stock option) for government help, extended their balance sheets by adding billions in debt and have in some cases diluted shareholders by raising equity at multiyear share-price lows. The airlines have promised no layoffs until September 30th.
Things look pretty bad at the moment indeed. Famed investor Warren Buffet certainly doesn’t want to be a holder of these companies at their current levels: His Berkshire Hathaway has sold out of their 4 airline holdings, Delta, Southwest, American and United. Buffett has uttered such words as “the world has changed” for airlines because of coronavirus and that the outbreak could have an “extraordinarily wide” range of possible outcomes. Atlanta-based Delta was burning through $100 million dollars of cash at the end of the March. Even jet manufacturer Boeing CEO David Calhoun has stated that at least one of the major airlines is going to declare bankruptcy.
To make matter’s worse, a very popular ‘technical’ pattern has recently emerged which would have many investors frankly run away from investing in airlines at these levels. The pattern is the popular ‘bearish pennant’ formation which the majority of airlines find themselves in at the moment. In this pattern, after a steep drop-off, prices quickly consolidate for a small period of time then proceed to break-through their recent lows. When this support price level is violated, prices tends to decline significantly. Not a good sign.
While we are in the midst of all this horrible news for the sector and the monumental declines, is it time to dip your foot in the water and add some of the airlines to your investment portfolio?
One thing I’ve learned in my career in the investment management business is that just because a share price falls by 50-70% it certainly doesn’t mean it’s cheap and should be bought. But that may not be the case with the airlines. I think it’s times like these that a ‘contrarian’ investor who is able to buck the trend, and even experience further small losses, can come out significantly ahead down the road.
What we are seeing with the airline sector is not one or two companies that are gravely struggling due to their individual operational misfortune. We are witnessing an entire industry get decimated due to factors out of their control. This to me presents an opportunity, particularly if we see another equity sell-off like many analysts are predicting. An impending recession could make these companies an even bigger opportunity.
Are airline shares ‘cheap’ at their current level? We won’t get into a detailed discussion of discounted cash flow models, comparable ratios or either valuation techniques to determine why airlines trade at their given prices (beyond the scope of this discussion). I’m a firm believer in the theory of efficient markets and that at any point in time the millions of investors around the world have bid on individual security prices and have them priced at their true intrinsic value.
Investing in the shares of any common stock always presents a certain amount of risk. Of course, the big ‘what if’ with airline travel is a cure/treatment for COVID-19. With no vaccine available at the moment, people are nervous of flying and may be so for the next couple of years. But what happens a year or two out when, it may be very likely that a vaccine is available and COVID-19 is a thing of the past, even a bad memory? This is where big money is made in stocks, taking a calculated gamble when things look their absolute bleakest and potentially having a huge payoff down the road.
Investors have to be somewhat contrarian in the face of uncertainty and look at what the world will look like when COVID-19 settles down. Clearly people need to fly and the industry as whole will not disappear. There is no substitute for air travel. Airlines are not coal producers, for example, that are undergoing a seizemic shift in demand. Airlines are also not a fly-by-night technology company with a quick fad that can be replicated. People are going to fly again, planes will be full, it’s just a matter of when.
Remember the Great Recession and oil prices blasting through the roof (taking the cost of jet fuel with it)? Delta Airlines, for example, went from a high of $20 to $5 in just over a year-and-a-half from mid-2007 to 2009. Delta was briefly over $60 last year. Not a bad return if you had bought in back in those days when things for the industry looked horrible.
Currently, it appears that the panic with air travel has already begun to fade. Shares prices have risen dramatically over the past couple weeks on signs that travel is returning. The Transportation Security Administration screened more than 391,882 travelers on June 4, which was the busiest day since March 22. American Airlines on the same day said that it was restoring a significant number of flights as travel interest is starting to return. American said it averaged 110,330 passengers per day in the last week of May, more than triple the 32,154 daily passenger average for April (which propelled American Airline stock 40% in a single trading session). Bank of America airline analyst Andrew Didora recently declared that the “leisure rebound is real” and saying that tourists and vacationers are once again looking to take to the skies.
My point in this article is not to ‘go for the home run’ and invest 50% of your investment portfolio in any individual airline. This could be a disaster, especially if you are 5 years or so away from retirement and things don’t improve for these companies. What I am attempting to get across is when an entire industry gets demolished that certainly is not going to disappear is to take a hard look at your appetite for risk and determine if you are able to stomach further declines for the potential for big future returns.
The best way to get exposure to airlines? Unless you are a savvy investor able to value any individual company on your own, an exchange traded fund that holds a wide swath of airlines could be a good bet. The U.S. Global Jets ETF from fund company U.S. Global Investors is the only product available at this time. Currently it holds 12.02% in American, 11.67% in SouthWest, 9.69% in Delta, all the way down to 3.66% in Mesa Air (top 10 holdings). It has $646 million in the way of net assets and pays a 2.58% dividend for investors along the way. If you want to take more of a calculated risk, many airline analysts suggest sticking with the ‘best of breed’ airlines. In particular, Delta (ticker: DAL) and SouthWest (ticker: SW).
With any individual stock purchase comes risk and at this point the immediate future (one to two years) for the airlines does not look healthy. But if one begins to ‘nibble in’ and take a small position, the payoff a couple years out could be enormous.