What happened
Shares of major airlines were enjoying a rare up day on Thursday, fueled by a broader market rally and some commentary on when the COVID-19-induced demand slump might recede. There's surely money to be made on the stocks if the airlines can fly through this crisis without heading into bankruptcy, but investors in recent weeks have been loath to assume that's a given.
Shares of Delta Air Lines (DAL +1.46%) peaked at up 7.1% today, while shares of American Airlines Group (AAL +1.11%), United Airlines Holdings (UAL +2.80%), and Southwest Airlines (LUV +2.37%) all traded up more than 5%. The gains were fading heading into the close, a sign of how much uncertainty there is around airline stocks right now.
So what
Airlines have been hit hard by the pandemic, which has caused demand for travel to evaporate and has caused companies that just a few months ago were looking to expand to instead retrench and cut costs. The industry lost billions in the first quarter, and the second-quarter figures to be even worse as carriers cut schedules by 90% or more into the summer.
Image source: Getty Images.
The situation is so dire Warren Buffett decided to sell his large stakes in each of those so-called "big four" airlines, and declare he had made a mistake buying into the sector.
The pandemic has undeniably taken its toll on the airline sector and will continue to do so for some time. The questions hanging over the stocks today are about exactly how long the impact will last, and whether it will get worse before it gets better. JetBlue Airways offered at least a ray of hope on Thursday when the company said it believes "we reached the bottom in terms of demand" around mid-April, and that they expect to have a clearer feel for the second half of 2020 by early summer.
That is not predicting a quick turnaround. It is quite possible we will see demand flatline for some time, especially if the post-pandemic U.S. economy is in a recession. But investors right now crave clarity, and a sense about how long the carriers will have to continue burning through tens of millions in cash daily. The idea that we could have a clearer picture of where the industry stands as soon as June is incremental good news.
Now what
All four of these stocks are down more than 50% year to date. I've been saying for a while now it will likely be hard for the stocks to find a bottom as long as there is so much uncertainty about the broader economy, but in recent weeks as states have begun to reopen, or at least start discussions about how to reopen, investors have started to look for the light at the end of the tunnel.
All four of these stocks also appear undervalued, assuming the companies don't end up in bankruptcy. All trade at less than 0.6 times trailing-12-month sales, and American trades at less than 0.1 times sales. Granted, revenue is going to be way down this year, but if you believe travel demand will eventually return, and have the patience to wait out that return, there is a chance to make outsized returns with these stocks.
Given the uncertainty and the risk the airlines could run out of cash before demand returns, I'd recommend sticking with top operators like Delta and Southwest. And be warned it is likely that other sectors will break free from a downturn long before the airlines will. But if you understand and accept the risks, it is possible to buy into airlines right now.
