Many investors have been keeping a close eye on the stocks of the major U.S. airlines following the beginning of the Covid-19 pandemic and the resulting crash of their stock prices as transportation demand faltered.
Even Warren Buffett (Trades, Portfolio), who is known for preferring to hold his investments forever if possible, sold out of his stakes in American Airlines (AAL, Financial), United Airlines (UAL, Financial), Delta (DAL, Financial) and Southwest (LUV, Financial) in the second quarter due to the uncertainty of when demand would return and how far the government would be willing to go to help the airline industry's debt-ridden top players avoid bankruptcy.
The share prices of all four of the biggest U.S. airlines are still down year to date, and analysts are expecting their profits will recover gradually, perhaps returning to 2019 levels sometime after 2022.
In addition, the lobbying efforts of the airlines and their workers' unions finally paid off, with the latest Covid-19 stimulus bill passed by Congress earmarking $15 billion to fund their payrolls – no restructuring needed. This rescue comes just in time to prevent Southwest from needing to furlough employees and allows the other airlines majors, which are in even worse financial shape due to higher debt before the pandemic, to bring back over 32,000 furloughed employees.
The details of the new assistance program are not yet clear, but considering that the portion of the bill related to air carriers was short and to the point, simply setting aside the $15 billion "exclusively for the payment of employee wages, salaries, and benefits," it is expected to mostly mirror the previous bailout in March, with the airlines receiving aid expected to pay back 30% of the payroll loans and offer warrants to the government. The airlines also must meet minimum flight requirements in order to receive the aid.
It seems investors finally have an answer to the question of whether the government will bail out airlines and whether that bailout will include restructuring that could wipe out shareholders. Could this support, combined with the anticipated recovery in a few years' time, mean that any of these stocks are a buy at current levels? Let's take a look.
American Airlines
American was the first major U.S. airline to begin ditching many of its initial Covid-19 precautions. Customers were reporting fully booked flights beginning in July. From this, we can see how American Airlines' weaker financial position relative to competitors affected it. After the previous round of aid ran out on Oct. 1, American cut around 19,000 jobs and halted service to at least 15 remote markets, mainly in the south-central U.S.
Thus, it would seem that American might benefit the most from the government covering its payrolls. It is still possible that having to meet the flight requirements could drive the company further into the red, but at the same time, this will help the company keep its market share rather than losing out to competitors.
"This PSP extension will enable us to bring furloughed team members back to work and resume air service to cities and towns that rely on us — all at a critical moment," CEO Doug Parker said in an official statement after the bill was passed.
That being said, things are still getting worse on the company's balance sheet. With an Altman Z-Score of -0.07, a Piotriski F-Score of 2 out of 9 and a current ratio of 0.74, if any of the major airlines is going to be forced into restructuring despite billions in government aid, it would most likely be American Airlines.
According to estimates from Morningstar analysts, the company is expected to post and earnings loss of around $18.34 per share in 2020, followed by a loss of $5.69 per share in 2021 and earnings per share of 29 cents in 2022, as compared to earnings of $3.79 per share in 2019.
The GuruFocus Value chart shows the stock has a GF Value of $10.71 while trading at $16.06, indicating that it is overvalued by 49%. Investors buying on the anticipation of improving results in the future could need to wait until the fourth quarter of 2021 for the GF Value to surpass the current share price.
United Airlines
As the second-most cash-strapped airline after American, United Airlines was also the second to begin booking middle seats and limiting Covid-19 precautions that prevented booking full flights. It cut around 13,000 jobs after Oct. 1, with only a cost-cutting deal with its pilots' union putting off another 3,000 job cuts until 2021.
Despite the aid money, United does not seem too optimistic on the funds having any long-term affect on the company. The company plans to use the payroll assistance funds until they run out, at which point it fully expects to have to furlough the employees again, as stated in its letter to employees following the news of the bill being passed:
"Now, those employees who are eligible under the terms of the PSP extension can temporarily come back to United through March 2021… Importantly, though, we don't expect customer demand to change much between now and the end of the first quarter of 2021. United has been realistic about our outlook throughout the crisis, and we've tried to give you an honest assessment every step of the way. The truth is, we just don't see anything in the data that shows a huge difference in bookings over the next few months. That is why we expect the recall will be temporary."
In terms of its financial strength, United has an Altman Z-Score of 0.37, a Piotroski F-Score of 2 out of 9 and a current ratio of 1.04, meaning it is still in bad financial shape, though not as bad as American.
According to estimates from Morningstar analysts, the company is expected to post an earnings loss of around $23.58 per share in 2020, a per-share loss of $6.93 in 2021 and earnings of $3.63 in 2022, as compared to the $11.58 it brought in in 2019.
The GuruFocus Value chart shows the stock has a GF Value of $28.92 while trading at $44.65, indicating that it is overvalued by 54%. Investors buying on the anticipation of improving results in the future could need to wait until the fourth quarter of 2021 for the GF Value to surpass the current share price.
Delta Air Lines
Delta is the airline that is widely considered to have had 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 also consider its increased ticket flexibility a bonus. Unsurprisingly, this corresponds with Delta's healthier balance sheet. So far, it has also avoided furloughs, managing to get by on persuading some employees to retire early or take voluntary leave.
Unfortunately for Delta, it will not benefit from the recent round of aid as much as its more cash-strapped competitors, as it did not have to furlough workers. However, the pay cuts that it negotiated with pilots will be paused and the aid may serve as a backup option if things were to suddenly take a turn for the worse. Not taking the aid would also mean that Delta would not have to issue warrants to the government.
In a letter to employees earlier in December (before the latest Covid-19 relief bill was passed), the company said it planned to bring back all workers by Jan. 1, though at the same time it was still asking for employees to take voluntary leave if possible.
Turning to the balance sheet, Delta has an Altman Z-Score of 0.08, but the Piotroski F-Score of 3 out of 9 and the current ratio of 1.27 are stronger than competitors.
For earnings per share, Morningstar analysts expect the company to post a loss of $19.83 in 2020, a loss of $1.56 in 2021 and earnings of $2.99 in 2022, as compared to the $7.30 it posted in 2019.
The GuruFocus Value chart shows the stock has a GF Value of $21.91 while trading at $40.56, indicating that it is overvalued by 85%. Investors buying on the anticipation of improving results in the future could need to wait until the second quarter of 2022 for the GF Value to surpass the current share price.
Southwest Airlines
Southwest didn'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. Like Delta, Southwest also felt confident enough in its financial strength to keep middle seats closed through November.
However, the company did threaten to furlough some of its workers come 2021 if no aid was forthcoming from the government, so the relief bill comes just in time to put off the jobs it would have cut.
Following the bill's passing, CEO Gary Kelly told employees that the federal aid "was always our preferred plan, and it means we can stop the movement toward furloughs and pay cuts that we previously announced." However, he also said the airline was "still overstaffed" and urged more employees to voluntarily take time off, indicating troubles might be greater than they appear.
On its balance sheet, Southwest has an Altman Z-Score of 1.7, which is miles better than its peers but still in the bankruptcy risk zone. The Piotroski F-Score of 3 out of 9 and current ratio of 2.07 also indicate a better financial situation than the other major airlines.
For earnings per share, Morningstar analysts expect the company to bring in a loss of $5.51 in 2020, a loss of 34 cents in 2021 and earnings $2.66 in 2022, as compared to the $4.27 it earned in 2019.
The GuruFocus Value chart shows the stock has a GF Value of $21.66 while trading at $46.41, indicating that it is overvalued by 114%. Investors buying on the anticipation of improving results in the future could need to wait until the fourth quarter of 2022 for the GF Value to surpass the current share price.
Conclusion
The latest round of government aid has come to airlines just as even the more stalwart giants were planning on furloughing employees by the thousands. However, according to statements from the airlines themselves, this aid seems to be merely putting off the inevitable. With the industry's cash burn well into the hundred millions per day, this cash-guzzling industry may yet prove a difficult place to stay afloat as long as demand remains depressed. This is especially true for the airlines with higher debt.
Overall, it seems that the market has already done a good job of pricing in the risk-reward ratios of these stocks. The ones with a higher chance of bankruptcy are trading much cheaper than those with a lower risk, and investors will likely need to wait a couple of years for the value of their investments to match the price paid.
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.
Read more here:
- Third Point Takes an Activist Stance on Intel
- IAC's Latest Spinoff Is Attracting a High Price Tag
- Accenture's Quarterly Results Surpass All Expectations
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
