Airline Stocks Dip As Air Travel Slips Once Again
Investors curbed their enthusiasm for airline stocks this week. As we enter the second-quarter earnings, airlines are set to report the damages from the coronavirus pandemic. Delta Air Lines (DAL Stock Report) led the opening by reporting massive quarterly losses. This highlights the depths of airlines’ near-term challenges. The outlook for the airline industry appears to be worsening with the rise in coronavirus cases.
After the crash in stock prices in March, many retailers sensed an opportunity to pick airline stocks up for cheap. If you are one of them, kudos to you. The problem here is, the plot has thickened with much of those gains being erased. Now that most airline stocks are trading near the March levels again, would you be tempted to buy at such valuation again? Maybe we should start asking ourselves, what kind of results airlines need to report to demonstrate true recovery?
As coronavirus cases rise sharply, airlines are once again cutting down on flight schedules to limit the spread of Covid-19. For instance, Delta Air is cutting 8% of its domestic flights and 16% of its international flights. For this reason, DAL stocks are plummeting again, just shy of its March’s low. Shares of American Airlines (AAL Stock Report) and United Airlines (UAL Stock Report) have dropped 60% and 64% respectively year to date.
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Cash Burn Remains One Important Factor To Watch If You Are Planning To Invest In Airline Stocks
The key factor most investors are looking at is not how much demand airlines are picking up. That’s because there’s a low chance we could see pre-COVID levels of demand anytime soon unless there’s a vaccine. Rather, investors’ focus should lie on the cost-cutting initiatives undertaken by airlines. Several airlines have announced plans for widespread layoffs when the payroll support from Cares Act runs out. Cash burn has been the focus and will remain a focus in the near-term. Also, the recent weaknesses shown from the Transportation Security Administration and bookings don’t paint an optimistic outlook for the third quarter.
Long Road To Recovery For Airline Stocks
Like it or not, it is gonna take more than a while for airlines to go back to pre-COVID valuations. Could lower fuel prices and the current cost-cutting initiatives lead to a sharp increase in margins? That may be possible, but the systemwide monthly volume would have to climb to at least 60 million passengers. That assumes steady pricing despite likely lower demand, and higher margins despite lost economies of scale. The additional debt taken on by carriers will also lead to higher cash outflows for loan repayments. As such, many do not expect a complete turnaround occurring in 2020.
Given that true recovery is still far away, there may be an opportunity for long term investors. The current prices may still be attractive for value investors looking for high-quality stocks with upside. But it will likely be an investment that tests one’s patience.
None of the airlines is expected to report a profit. As Myles Walton from UBS puts it: “it goes without saying that the second quarter is a throwaway quarter for U.S. airlines as revenue is largely nonexistent.”
Deciding on whether to invest in airline stocks requires strong balancing of a few key factors. The debt levels, ongoing cash burn and the risk that vaccines are not widely available could prolong extended periods of weak demand. In other words, when looking to buy airline stocks, invest in those that have higher chances of weathering the Covid-19 storm. Invest in those that have solid balance sheets. For instance, Delta Air and Southwest Airlines (LUV Stock Report) are both airlines with sufficient cash buffers that wouldn’t need to take on an unsustainable amount of debt. This in effect, allows them to eventually rebound when there is higher air traffic demand