Airline stocks took off on Wednesday, boosted by improving sentiment about air travel trends. In recent days, the TSA has been screening 12% to 14% of the number of passengers that typically would pass through its checkpoints at this time of year -- a big improvement from mid-April, when the TSA's reported throughput was just 4% of prior-year levels. Still, passenger traffic remains incredibly weak, and it's clear that there won't be a quick recovery in demand.
However, shareholders of one airline -- Alaska Air Group (NYSE:ALK) -- had greater cause for optimism. After the market closed on Tuesday, the Alaska Airlines parent reported that it dramatically reduced its cash burn in May. As a result, Alaska Air stock surged as much as 12% on Wednesday, before pulling back to end the day at $39.30, up nearly 9%.
A financially strong airline
Alaska Air's management has taken a fairly conservative approach to managing the company's balance sheet over the years. While Alaska did take on about $2 billion of debt to buy smaller rival Virgin America in late 2016, it spent most of the next three years repaying those borrowings. By the end of 2019, it had repaid 75% of its acquisition-related debt, reducing its debt-to-capitalization ratio to 41% (down from 51% three years earlier).
This put Alaska Air in a strong position to manage through the severe headwinds associated with the COVID-19 pandemic. It entered 2020 with just $3.2 billion of debt and lease liabilities, partially offset by $1.5 billion of cash on its balance sheet. Furthermore, many of its aircraft and other assets were unencumbered, enabling the carrier to raise additional cash by issuing cheap secured debt.
As a result, despite the impact of the pandemic, Alaska boosted its cash and investments balance to $2.8 billion by May 12. In addition to the $992 million of payroll support it received under the CARES Act (of which $267 million came in the form of a low-interest loan), Alaska drew down $400 million from its credit facilities and issued $475 million of new secured debt in the first four-plus months of 2020.
This gives Alaska a substantial liquidity cushion. That said, management disclosed on the Q1 earnings call that Alaska Airlines burned $400 million of cash in March and another $260 million in April. Unless cash burn slows dramatically in the months ahead -- and stops reasonably soon -- the company could be forced to raise additional debt, impairing Alaska Air stock's long-term value.
Cash burn improvements, as promised
In conjunction with the Q1 earnings report, Alaska's management said that monthly cash burn should slow to $200 million by June. The company also set out a goal of reaching break-even cash flow by year-end. So far, those plans appear to be on track.
On Tuesday, Alaska Air disclosed a significant sequential improvement in its performance last month. The airline slashed capacity 79% year over year in May, similar to the 78% reduction implemented in April. Yet while load factor (the percentage of seats filled with paying customers) came in at just 15% in April -- despite the big capacity reduction -- load factor improved to around 40% in May. This highlights the sequential increase in demand.
As a result, Alaska burned just $170 million of cash last month -- a big improvement from April. The company said it still expects to burn $200 million of cash in June, though. It's not clear if that's just a conservative forecast or if lumpiness in the timing of receipts and expenditures is driving the projected trend change.
Regardless of whether cash burn is improving steadily or in lumpier fashion, it's clear that between the gradual return of demand and cost cuts, Alaska Airlines is making progress toward its break-even target.
Alaska Air stock still looks attractive
Less than a month ago, Alaska Air stock traded for around $25. Since then, the stock has rallied more than 50%, although it is still trading well below its 52-week high of $72.22. The recent investor update highlights why the shares remain attractive, even if they're trading at a smaller discount than they were a few weeks ago.
Alaska Airlines has a lower cost structure than the three big legacy carriers that dominate the U.S. airline industry. That should allow it to reach cash breakeven faster, as it can better adapt to the ultracompetitive, low-fare environment that is likely in the near term. It also has minimal international exposure, which is a big plus, as industry experts expect domestic travel to recover much faster than international travel.
Importantly, Alaska Airlines has substantial fleet flexibility. It has deferred all aircraft capital expenditures until at least 2021, preserving cash. Meanwhile, leases for dozens of older, less-efficient Airbus A319s and A320s will expire between 2021 and 2023. That will allow Alaska to cost-effectively shrink its fleet to match lower demand over the next year or two. As demand returns, it will be able to replace those planes with larger, next-generation aircraft, supporting higher profit margins in the future.
Between the company's rock-solid balance sheet and improving cash flow trajectory, Alaska Air stock is well-positioned to return to its late-2019 high above $70 within a few years. That provides plenty of upside for patient shareholders.