Airlines have been hit hard by the COVID-19 pandemic, sending stocks crashing down and causing Warren Buffett to run for the emergency exits. Airlines today are trading at valuations that suggest they might not survive, and many prominent industry watchers are worried they might not.
Boeing, which counts on the airlines for the bulk of its revenue, is expecting the worst. During a May 12 television interview, CEO David Calhoun said a "major U.S. carrier" will "most likely" go out of business this year, predicting an extended decline in travel.
"Something will happen when September comes around. Traffic levels will not be back to 100%, they won't even be back to 25%," Calhoun said. "Maybe by the end of the year we approach 50%. So, there will definitely have to be adjustments that will have to be made by the airlines."
Calhoun may end up correct, though I don't think bankruptcy is a given. Still, it does seem likely that traffic will not return to pre-pandemic levels for years, and there is substantial risk to airlines. That risk is going to remain until we know more about how the pandemic is resolved and what the economy looks like when it is.
I don't think the airline sector is un-investible right now, but I do think investors need to understand the risks and choose carefully between carriers. Here's a post-earnings look at the U.S. sector, broken down by the level of risk to investors buying in.
Safer to buy
The first thing to note is that if traffic simply does not return, either due to another wave of outbreaks, economic difficulties, changing consumer preferences, or some combination of all three, no airline is safe. There are very few businesses that can survive indefinitely with little revenue coming in, and certainly no airline that can.
However, in anything other than the worst-case scenario, and even in Calhoun's slow recovery into the fall and 50% by year's end, there are airlines that look like they have the wherewithal to definitely survive.
Southwest Airlines (NYSE:LUV) shares have only lost about half their value year to date, which makes the company a winner among airline stocks. The airline has long been an investor favorite due to its simple business structure and ability to make money when others can't -- Southwest famously has never resorted to layoffs, even following the attacks of Sept. 11.
That could change by year's end if traffic does not return, but no matter what conditions lie ahead, Southwest has a fortress balance sheet at its disposal. The airline has also taken more of a surgical knife to its schedule rather than mass cuts. That is allowing it to keep selling into this period with little demand, and the strategy should help it to be among the first airlines to see real evidence of a turnaround.
Southwest is burning through $30 million to $35 million per day, but it still has levers to pull, including parking additional planes if conditions grow worse. It hopefully will not come to this, but Southwest is a safe bet to be the last airline standing in almost any nightmare scenario.
Delta Air Lines (NYSE:DAL) has earned a reputation as an industry innovator since emerging from bankruptcy more than a decade ago, revamping pricing to better compete against discounters and investing in foreign partners as a cost-effective way to provide global coverage. Delta also paid a dividend coming into this year, a rarity among major airlines.
The pandemic has caused the dividend to vanish and forced Delta to scale back its global plans, but there's still a lot to like about this company, including its top-class management team. In recent years, Delta management has redefined what a "legacy" airline is, and assuming the company makes it through the crisis, I expect its leaders to use it as an opportunity to continue to rethink how the airline business works.
Delta aims to end the current quarter with $10 billion in liquidity, and it has billions in unencumbered assets at its disposal if it needs to raise more money.
Alaska Air Group (NYSE:ALK) is smaller than Southwest or Delta, but the airline has a powerful franchise up and down the West Coast and historically has been a top operator. The company and the stock took a hit last decade as Alaska bought and integrated Virgin America, but that process is finally nearly complete, and coming into the pandemic, Alaska was taking a no-nonsense approach to cutting routes that weren't performing to focus more resources on its core strengths.
Alaska has nearly $3 billion in cash on hand, enough to survive for more than a year at current burn rates, although it has about $600 million in debt maturing in the first half of 2021. Airline management believes the company can hit cash burn breakeven by year end, which could mean they expect eventual workforce reductions.
The case for buying Alaska is that the company, with its simple structure, should be able to bounce back faster than some other airlines as traffic returns.
Better to wait
There are also several airlines I think are likely to survive, but they carry added risk and should be avoided for now. United Airlines Holdings (NASDAQ:UAL) has about $10 billion in total liquidity and expects to burn between $40 million and $45 million per day by the end of the quarter.
United was viewed as an impressive turnaround story heading into 2020, with its stock up more than 580% in the previous decade thanks to a campaign of cost cuts and improved ticket pricing that helped to increase margins. But the airline is also reliant on the energy and tech sectors due to its hubs in Houston and San Francisco, and United is navigating the crisis while proceeding with a previously planned management transition.
The airline might be a tempting option over Delta or Alaska if investors were offered a real bargain in exchange for taking on the added risk. But the company's shares have not fallen significantly more than shares of its rivals, and United actually trades at a premium multiple to earnings over Delta.
JetBlue Airways (NASDAQ:JBLU), meanwhile, is a much smaller airline, but it too is doing what it can to stem cash burn and ride out the storm. The company has $3.1 billion in total liquidity and intends to cut its daily cash burn to $7 million to $9 million by the third quarter. Management has delayed about $1.3 billion in capital expenditures it had planned over the next few years until later in the decade so it can instead focus on survival and then debt repayment.
JetBlue has the resources to survive, but the company's business model works best in economic boom times, not recessions. Heading into the crisis, JetBlue was focused on its Mint product, which offers premium amenities for higher fares. Even as traffic returns, the airline seems like a poor candidate to outperform its rivals assuming we are headed into a downturn.
Hawaiian Holdings (NASDAQ:HA) is a niche carrier reliant on tourism to a high-cost destination, and both the Hawaiian Islands and the airline lean on Asia for a significant portion of their volumes. International travel, both by U.S. passengers and foreign passengers, seems likely to return slower than domestic travel. Hawaiian also by its nature has a higher-cost footprint, as much of its flying is long-haul transpacific.
Because of this, Hawaiian can do everything right and still struggle to survive a downturn. I think it will survive, but until the economy rebounds, it will be difficult.
There are a few airlines that require special attention through this crisis. American Airlines Group (NASDAQ:AAL) was the last of the majors to restructure, and it remains behind its peers in terms of revamping pricing and operations. It also has an industry-high debt load. American expects liquidity to reach $11 billion by the end of the second quarter, and I believe it can survive, but if any major airline does succumb to bankruptcy, American is the most likely bet.
Spirit Airlines (NYSE:SAVE) also has a lot of debt, and the company's small size makes it harder to balance cutting flights and still remaining in compliance with government guidelines to continue service in order to receive bailout funds. But if Spirit can fly through the immediate crisis, its industry-low cost structure should help it better compete in what is likely to be a recessionary environment, a time when airlines typically offer lower fares to try to stimulate demand.
Finally, Allegiant Travel (NASDAQ:ALGT) operates a good airline and has a solid cost structure, but in recent years, the company has diversified into resort development, hotel management, golf, and ownership of a chain of family entertainment centers. Those businesses, which are in various stages of development, could weigh on cash balances and divert management's attention, especially if post-pandemic gathering restrictions remain in place.
The entire airline sector is going to face additional turbulence in the months to come. Investors who want to hop aboard should choose carefully, buckle up, and be prepared for a long ride.