Airlines have been among the hardest-hit businesses during the COVID-19 pandemic. For much of the spring, nearly all states were requiring people to stay home except for essential activities. In any case, with conventions canceled, businesses moving to remote work, theme parks closed, hotels offering limited service, and international travel severely restricted by travel bans, most Americans have had nowhere to go.

The resulting plunge in air travel demand caused airlines to begin hemorrhaging cash. As a result, shares of major airlines like American Airlines (NASDAQ:AAL), Delta Air Lines (NYSE:DAL), Southwest Airlines (NYSE:LUV), and United Airlines (NASDAQ:UAL) have lost half to two-thirds of their value over the past three months.

However, airline stocks bounced back in a big way this week, lifted by signs that travel demand is starting to recover. United Airlines shares led the way, surging 27.5%.

LUV Chart

Airline Stocks Weekly Performance, data by YCharts.

Nevertheless, investors should be cautious about jumping into airline stocks. So far, the "recovery" has been extremely modest, and it is likely to take several years for demand to fully return.

A trend change in U.S. air travel

The TSA has been providing daily data on passenger throughput at its security checkpoints for the past several months, offering a window into the rapid changes in air travel trends.

On March 1, the number of travelers passing through TSA checkpoints was down just 1% compared to the same weekday in 2019. However, traffic deteriorated rapidly over the course of the month. By March 16, passenger throughput was down 49% year over year; by March 31, it was down 93%.

Passenger throughput at TSA checkpoints finally bottomed out in mid-April at just 4% of 2019 levels. And throughput was down more than 90% year over year for every single day from March 26 to May 20.

That said, traffic through TSA checkpoints has been improving sequentially in recent weeks. For most of the past week, traffic has been around 9% of 2019 levels (more than double what was seen a month earlier). On Thursday, throughput reached its highest level in nearly two months at 12% of the prior-year figure, indicating that some people went ahead with Memorial Day weekend travel plans.

A mostly empty Delta Air Lines airport concourse

Air travel demand remains extremely limited for now. Image source: Delta Air Lines.

Airlines confirm green shoots

The gradual but steady trend toward higher passenger numbers reported by the TSA has made investors more optimistic about airlines. Comments by several airline executives at a recent industry conference added to this optimism, fueling last week's big rally in airline stocks.

For example, Southwest Airlines pointed to "a modest improvement in passenger demand, bookings, and trip cancellations" in May. As a result, Southwest now expects its May load factor to land between 25% and 30%. Previously, it had expected to fill fewer than 10% of available seats with paying customers. Revenue is on track to decline 85% to 90% year over year this month: about 5 percentage points better than Southwest's initial guidance. Importantly, new bookings are now exceeding cancellations, substantially reducing cash burn.

Other airlines are also seeing green shoots. Delta Air Lines CFO Paul Jacobson said that net bookings had turned positive on some days recently. That puts Delta on pace to exit the quarter with cash burn at around $40 million a day: $10 million better than what it expected a month ago. Delta's load factor has been about 35% to 40% in recent days. American Airlines' load factor has also improved to around 35%, helped by deep capacity cuts. United is seeing improved demand, too. As a result, it is planning a 75% year-over-year reduction in scheduled capacity for July, compared to 90% cuts in May and June.

Demand is still very low

It's encouraging to see trends moving in the right direction for airlines. That said, demand remains extremely low. Airlines will lose less money with passenger traffic down 88% than they did with traffic down 96%, but they will still lose a lot of money and burn through cash. Furthermore, as Delta's CFO warned, investors shouldn't make too much of the recent uptick in bookings, as people still may cancel their travel plans (e.g. if the number of COVID-19 cases starts to increase again).

It's also important to recognize that Americans hold a wide range of views about the threat posed by the pandemic. An Economist/YouGov poll earlier this month found that 64% of respondents were somewhat or very worried about contracting COVID-19. However, 11% were not worried at all and another 25% were "not too worried" about getting sick.

It's reasonable to guess that the recent uptick in travel is being driven primarily by the people who are not very worried about the pandemic. Based on that demand pool, getting back to 30% of 2019 traffic levels may be achievable over the next few months. But after that point, momentum could slow until there's a much broader consensus that it is safe to resume normal activities.

A Southwest Airlines plane preparing to land

Image source: Southwest Airlines.

While airlines are working hard to cut costs, even the most successful carriers are unlikely to return to profitability until demand reaches at least 60% or 70% of 2019 levels. Investors should expect losses to continue for at least a few more quarters (and possibly longer).

What does it mean for airline stocks?

With the air travel demand recovery likely to be slow, it's not surprising that American Airlines stock underperformed other airline stocks this week. American had a subpar balance sheet and below-average profitability even before COVID-19. Now, it has the least liquidity among peers and is burning cash the fastest. That creates significant bankruptcy risk.

By contrast, the big rally in United Airlines stock was very surprising. United has been very aggressive about cutting costs, but it will still suffer from a below-average balance sheet, high exposure to international travel, and greater exposure to competition than peers. These weaknesses could hurt the company's ability to recover from the current crisis.

On the other hand, companies like Delta and Southwest may be worth a look for investors. With higher margins under normal conditions, stronger balance sheets (especially at Southwest), and more flexibility to adapt to a rapidly changing demand environment, Delta Air Lines and Southwest Airlines should survive the COVID-19 pandemic with no permanent damage. That creates plenty of upside for both airline stocks, even if the recovery is slow and uneven.