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Margaret Moran
Margaret Moran
Articles (314) 

Revisiting Airline Stocks as Federal Aid Runs Out

As airline CEOs plead for federal funds, what might recovery look like?

September 18, 2020 | About:

On Thursday, the CEOs of American Airlines (NASDAQ:AAL), Southwest Airlines (NYSE:LUV) and United Airlines (NASDAQ:UAL) met with White House Chief of Staff Mark Meadows to plead the case for additional federal aid as their companies continue to flounder from lack of income.

Demand for air travel remains depressed due to the ongoing Covid-19 pandemic. Although passenger volume has increased since the initial drops in the first quarter, demand remains stuck at around 30% of the levels from a year ago. Under these conditions, the $25 billion in federal aid that the airlines received as part of the CARES Act in March is turning out to not be enough.

Focused on keeping air travel routes available, the CARES package required airlines to avoid cutting jobs through Sept. 30, but many of them are warning of massive job cuts as soon as that deadline passes. Airline executives and the unions that represent their employees are lobbying for an additional $25 billion in aid aiming to preserve jobs through March of 2021.

It seems safe to say at this point that the future of the airline industry will largely depend on whether or not more federal aid will be forthcoming. If it is, players that are struggling under higher debt burdens, like American Airlines, may catch a break and keep their market share. If it isn't, we may see new players or those with stronger balance sheets picking up the slack as some major airlines are forced to drop service to remote areas.

An agreement has not yet been reached, but following the meeting, the airline CEOs seemed optimistic, with Southwest CEO Gary Kelly commenting, "We had a very good meeting with the chief [of staff]."

With this in mind, let's take a look at the current states of the four major airlines – American, Southwest, United and Delta (NYSE:DAL) – and what changes might be in store.

American Airlines

American Airlines has been the most vocal in its bid for additional government funding, likely because it is the most strapped for cash. With a cash-debt ratio of 0.25, a current ratio of 0.94 and an Altman Z-Score of 0.28, American runs a high risk of bankruptcy if it cannot raise additional liquidity somehow, and the money is not likely to come from increased demand anytime soon.

American was the first major U.S. airline to begin ditching some of its initial Covid-19 precautions, with customers reporting fully booked beginning in July (meaning every single seat was full). From this, we can clearly see the airline's desperation for more passengers and lower operating costs as it consolidated passengers onto as few planes as possible.

After Oct. 1 rolls around, American expects to cut 19,000 jobs. It will also halt service to at least 15 additional remote markets on Oct. 7, mainly in the south-central U.S.

According to the GF Value Line, American Airlines is most likely a value trap, i.e., it seems to be undervalued but runs a high risk of permanent impairment to operations. Estimates from Morningstar analysts predict that the company's value will continue deteriorating through the end of 2020 before recovering to about two-thirds of 2019 levels by the end of 2022 as demand returns to the industry.

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Southwest Airlines

Southwest doesn't expect to have to make further job cuts this year after it successfully convinced 17,000 employees (about a fourth of its payroll) to voluntarily leave either temporarily or permanently. With a cash-debt ratio of 1.27, a current ratio of 1.70 and an Altman Z-Score of 1.95, the company is experiencing some financial stress but is still unlikely to face bankruptcy.

In order to decrease the spread of Covid-19, Southwest plans to keep the middle seats on its flights open through the end of September, effectively limiting its flights to 65% capacity and reducing the number of passengers who could transmit the virus to each other. The willingness to take the financial hit could be a further indicator of the company's financial strength.

Southwest recently reported that it plans to keep its middle seats vacant through Nov. 30. It also plans to initiate service to two additional airports by the end of 2020 – Miami International Airport and Palm Springs International Airport – pending government approval.

The GF Value Line indicates that shares of Southwest are currently fairly priced. Like with American, analysts expect Southwest's earnings to continue falling through the end of 2020 before entering a recovery period.

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United Airlines

Like American, United Airlines is also taking a tone of great urgency while attempting to secure further funding. The company has a cash-debt ratio of 0.3, a current ratio of 0.61 and an Altman Z-Score of 0.67, indicating a risk of bankruptcy in the next couple of years if it cannot get additional funds.

As of August, United Airlines has begun booking middle seats again, allowing planes to reach full capacity. It is keeping only the standard cleaning and mask policies in place. The change took place as many U.S. states were reporting rapidly increasing Covid-19 cases, so it was almost certainly a move made out of financial concerns.

United plans to cut 16,000 jobs after Oct. 1, though a more recent cost-cutting deal with its pilots' union could potentially preserve up to 3,000 jobs through 2021. The airline has not yet announced plans to cut service to more locations, instead planning to expand its network to include several nonstops to Africa, India and Hawaii staring in late 2020 and early 2021.

The GF Value Line flags United Airlines as a potential value trap. Though the stock looks undervalued, its weak financials could result in permanent damage, adding a risk for investors. Analyst estimates see the value of the company's earnings falling through 2020 and recovering about half of the lost income from 2019 by the end of 2022.

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Delta Air Lines

Among the four major airlines, Delta seems to be hanging on to the prospect of more government aid the least. While its balance sheet is not in quite as good condition as that of Southwest, it has a cash-debt ratio of 0.51, which is higher than 64% of other companies in the industry. The current ratio of 0.94 and Altman Z-Score of 0.59 suggest it still needs some improvements in cost-cutting or additional funding.

Delta is the airline that is widely considered to have the best response to the pandemic. It was the first carrier to begin boarding flights from back to front, as well as the first to reduce flight capacity to 60%, and customers consider its increased ticket flexibility a bonus.

Like Southwest, Delta also reported that it will not need to furlough "most" of its employees due to shorter schedules, voluntary leaves and buyouts. However, it is still in negotiations with its pilots' union about how to avoid 1,900 planned furloughs. To raise additional funds, the airline announced an extension of its SkyMiles debt offering to $9 billion, higher than the $6.5 billion originally planned.

The GF Value Line rates Delta shares as modestly undervalued, with the intrinsic value of shares expected to continue dropping through the end of 2020 before regaining about two-thirds of lost value by the end of 2022.

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Disclosure: Author owns no shares in any of the stocks mentioned. The mention of stocks in this article does not at any point constitute an investment recommendation. Investors should always conduct their own careful research and/or consult registered investment advisors before taking action in the stock market.

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