In this episode of Industry Focus: Energy, Nick Sciple chats with Motley Fool contributor, Lou Whiteman, about the airline industry. They start things off with a new IPO announcement. Next, they go on to provide a holistic view of the airline industry and take us through the measures the different players are taking to adjust to the market. They discuss the recovery and growth prospect of the industry, three companies in particular, and much more.
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This video was recorded on June 4, 2020.
Nick Sciple: Welcome to Industry Focus. I'm your host Nick Sciple, joining me today is Industry Focus contributor, Lou Whiteman. Lou, welcome back to the show.
Lou Whiteman: Thanks for having me.
Sciple: Great to have you, Lou, you know, you're hopping on late notice here today, we had planned to have John Rosevear on to talk about Nikola Motor, which is officially going public today via SPAC. [Special Purpose Acquisition Company] An exciting company, they describe in their filing documents Nikola Motor is a vertically integrated zero emissions transportation solution provider that designs and manufactures state-of-the-art battery, electric and hydrogen fuel cell electric vehicles, electric vehicle drive trains, energy storage systems and hydrogen fueling stations. So really, they want to revolutionize the logistics industry when it comes to how these vehicles are fueled.
I haven't dived into this too deeply, Lou, but when you see this filing, anything pops out to you about this company?
Whiteman: You know, it's a huge potential market and it's an important market. Transportation is the biggest source of greenhouse gases and heavy-duty trucks make up more than one-quarter of total transport emissions, so this is an important problem to solve. The company has high hopes, they're talking, I think, but they're not going to start producing trucks until 2023, and they hope to have 5% of the total market by 2024.
They have good leadership, it's just, they've gone up against a lot of heavyweights, it's pre-revenue, they're not going to even have revenue until 2023 or so. Be warned, hope for the best and just don't bite too hard on this because it's all speculative until they're out on the roads.
Sciple: Yes. They expect to start producing their battery electric vehicles in 2021 and start producing their fuel cell electric vehicles in 2023. They already have some deposits in place from customers, most notably, Anheuser-Busch, to start providing those fuel cell electric vehicles. A big opportunity there, when you look at this heavy trucking part of the market. This is an area where fuel cells make a little bit more sense than EVs.
But to your point, Lou, there is a lot of execution risk here, they're going to have to scale up their hydrogen refueling infrastructure at the same time they're building up their fleet of vehicles. So, it's kind of one of those situations where you're laying the railroad track at the same time that the train is hurtling down behind you. But it's certainly a big opportunity there. And hopefully, John will be feeling better next week and we can dive a little bit deeper into this Nikola IPO.
But since we've got you here today, Lou, I wanted to talk about airlines. Over the past month the whole sector has been on a tear, I pulled up the JETS ETF, up 33% in the last month. Obviously, with coronavirus, flights being cancelled, airlines have been really in the news these past several months, what has been going on in the sector that's really caused this recent surge?
Whiteman: Yeah, the good news is that, yeah, they're up 33% in the last month. The bad news is that's off a very low base. From mid-February through mid-April, every U.S. branded airline, all nine companies, were down at least 43%. You take Southwest Airlines (LUV +2.00%) out of there and everyone has lost more than half of their value, even with this rally, and it has been a good rally, it's been a good month. The entire industry is down between 27% and 57% year-to-date. This has been a tough, tough place to be with COVID-19.
We've gone from everybody was assumed to go bankrupt, to we've, sort of, stabilized thanks to their fundraising efforts and the CARES Act, and the stimulus. So, now we have a runway, now we need to see demand return before the revenue runs out, because most businesses, definitely not airlines, they can't run with no cash coming through the door.
Sciple: Absolutely. So, one of the big things was, are these airlines going to have access to capital? And these folks have really been able to raise significant amounts of money in recent weeks.
Whiteman: Lost in the narrative, this has been a terrible place to invest since deregulation in the late-1970s. And so, airlines have a really well-earned reputation for being poorly run companies. Lost in the narrative has been that that has largely changed over the last decade or so. The last round of bankruptcies, the decade that followed, this last decade, there aren't the weak players in this industry anymore. They came into this recession a lot better off than people gave them credit for, and they've been able to take responsible moves, and like I say, at least buy themselves time.
Sciple: Absolutely. So, one of those airlines that I wanted to talk about with you a little bit, Lou, is Spirit Airlines (SAVE +0.00%), ticker SAVE, an easy one to remember. When you look at the sector, up 61% in the past month, Spirit has been one of the best performers. I know this is a company that you follow closely.
Whiteman: It is, it's actually a stock I own, I'll disclose, prior to any of this happening. So, I've felt the pain there. Spirit lost more than most too. They lost nearly 80% of their share value between mid-February and mid-March. This is a fringe carrier, no one is going to say that this carrier has to be saved the way a Delta (DAL +6.56%), an American (NASDAQ: AAL), someone like that. They're the butt of a lot of late-night jokes. They're the ones that charge for everything; they charge you for your seat, they charge you for your carry-on.
If the disaster came that people were worried about, Spirit was going to be pretty low on the list to be saved, plus they were priced more than any other airline for growth, and so as that growth trajectory began to slow, even in the best case scenarios, there was less reason to be in these shares. But, you know, the harder they fall, the harder they come up. And now, if we're to appoint, and we can talk about it some, where there's some green shoots, there's reason to believe that maybe the industry has bounced off the bottom.
Spirit really looks intriguing here, in part because they call themselves an ultra-low-cost carrier. They are mostly a leisure business and historically that recovers first, because with leisure fares it's easier to stimulate travel by cutting fares and going cheaper. Spirit is the low-cost provider. They can make money on fare levels that nobody else can. A measure in the industry, it's Cost Per Available Seat Mile, [CASM] it's basically how much it costs to move one seat one mile. Spirit's 2019 number was 7.97 cents. Southwest Airlines, which is the discount king, the first one everyone thinks about, their number was 11.74 cents. So, Spirit is quite simply, if this becomes a price war, they can win that war. And so, I think, as the recovery has hopefully maybe started to occur, they are really intriguing one to buy off the bottom.
Sciple: Lou, we talk about pricing. One area I've been curious about, maybe you have some thoughts here, in the wake of COVID there's been this push to de-densify planes, remove the middle seat. What does that do to these business' operations, are we going to have to see ticket prices come up? How will that affect these businesses going forward?
Whiteman: Yeah, that's a great point. And we should add that part of Spirit's cost advantage is, if they pack people on the planes, and so that is going to erode some. It's going to happen for the entire industry, so I don't think it negates their cost advantage, but that spread may close. You know, there are a lot of moving levers that have to be adjusted together. With fewer seats on the plane, and I think Delta just said they're not going to sell middle seats through to the end of September, so we're looking long-term.
With fewer seats on the plane, yes, there could be -- in theory, there's less supply, prices should go up. The airlines are still flying a very small portion of their schedules. And by law, they have to keep employees on the books through September 30th. I think that as demand starts coming in, you're going to see airlines adding planes more than you are going to see them really hiking up fares; and I think we got an example of that today with American. But yes, there is some sort of equilibrium that has to be reached between supply and demand that it could be that you should have bought a month ago.
Sciple: Well, that was the next question I wanted to go to you, Lou. Obviously, when you talk [laughs] about a month ago, Berkshire Hathaway's annual meeting took place at the beginning of May, do you think Warren Buffett called the bottom on airlines?
Whiteman: I mean, you know, as a Berkshire shareholder, especially, I don't want to spike the football on Warren Buffett and it's way too early for that. But, yes, since the May 2nd Berkshire annual meeting, when we found out that Berkshire was a 10% or close to 10% holder in all of the big four airlines, Delta, American, United (NASDAQ: UAL) and Southwest, they liquidated everything in the first quarter of the year and Buffett basically said, I give up, I was wrong. Since he said that, United was up 42%, American is up 38%, Delta and Southwest were up 30%. It has been a heck of a run from these companies, off a bottom that Buffett helped create, because when people heard that, the stocks did sell off.
You know, I argued at the time, I didn't like the move, it's way too soon to say if that was correct or not, simply because we can't predict a pandemic. If we have a devastating second wave we're still waiting for revenue, we still only have a runway, all of these companies could still go to zero in the worst-case scenario. But with each little uptick we're seeing, American today said they're going to fly 55% of their 2019 schedule in July. They were at 20% or 30% a month-and-a-half ago. As incremental revenue starts coming back into the system, that runway gets stretched out into late-2020 and 2021. We have a longer time that they can survive and the better these stocks start looking.
Sciple: Yeah, Lou, so I wanted to follow-up on that when we look out long-term, a big part of what Warren Buffett said when he sold the stock is, hey, the long-term thesis for these companies have changed. I don't know that the growth trajectory for airline travel is the same today than it was when he first invested in these companies. And we're still in the midst of this global pandemic, airlines are still significantly depressed when it comes to actual flight, they're taking relative to where they were before. But as we start looking out into the future and starting to get a view into what the new normal might be, when it comes to airline demand in this industry more broadly, how long do you think we'll have to wait or how much data do we need to see until we can make a call on how much demand is permanently destroyed or whether this industry can return back to the trajectory it was on before the pandemic?
Whiteman: I personally think that we will go back to pre-pandemic levels, but I do think it's going to be a 2023 or later, which speaks to the severity of the downturn. The make-up of that capacity is still open to question. International has traditionally been the most lucrative. I think there still will be international demand, you can't get in a car and drive to Japan, right? But will the airlines that were taking risks, buying planes, flying the world on their own mettle, will they do that with their international partners in the future, will they be sharing that revenue, will corporate trends ever recover? I mean, I personally can imagine Zoom really replacing all the sales calls, I can imagine Zoom replacing some of the trip up to New York for a meeting-type, which is part of the overall corporate bill. So, what travel looks like in the future remains to be seen.
The airlines also have a lot of flexibility on what they look like as far as their capacity and what they're flying, how much. I believe the industry can profitably adjust to what will be a healthy demand long-term. I believe people still want to travel and want to fly. But, yeah, I wouldn't be surprised if we never see 2019 again in terms of the mix and what travel looks like.
In terms of metric, I think the good news is, the airlines have been very transparent about what they're seeing; I hope that continues much more so than normal. American today, Delta last week, they are telling us exactly what's coming through the door and what's going out. The Transportation Security Administration is also doing a daily chart where they're telling you how many people go through security. We can monitor this, I mean, American carried about 110,000 passengers a day last week. That number was at 32,000/day in April. They are still a long way from 2019. But honestly, as long as they want to give us that information, I think that's the best to go to. They are telling you in real-time what they're seeing.
Sciple: Absolutely, we get this real-time data. And I think one thing that came to mind too, when you talked about international travel is, we've seen the airlines make some choices when it comes to their portfolio of planes. I believe it was Delta that announced changes to how they were going to use the 777.
Whiteman: Yeah, they are actually retiring their 777s, which is right now, they were the longest leg on the fleet. Their current planes, they cannot hit some of the destinations they've gone to in the past. They have planes on order, some airbuses that will eventually hit most of those. But I do think Delta, in particular, has been very good over the years in investing in foreign partners, and that has not looked so good in recent months because a lot of those foreign partners, one of them filed for bankruptcy. Delta invested $2 billion in LATAM down in South America just last year, that equity stake is all but wiped out, that looks like a very bad choice right now. If they survive, and the partnership remains, and Delta can hit South American using their planes in the future, not commit to tens of millions in new planes, it still can be a winner.
But, yeah, it's going to be interesting to see what they do and it's probably only taken one good bull market for them to really start expanding again. But I would think for the next 5+ years, you're going to see a lot of conservatism, if nothing else, while they're paying down the debt they've taken on.
Sciple: Right. And that brings on to the next company I wanted to talk about, Lou, when we talk about these airlines, the issues that have been faced by COVID, but Boeing (BA 1.24%) always comes into this conversation as well. With these strange dynamics and what we see as far as recovery in the airline space, what does that mean for Boeing?
Whiteman: Yeah, I mean, it is amazing, I mean, Boeing, we are not talking about a small company here. Boeing had generated $100 billion in revenue in 2018. This is a top blue-chip company that saw its stock fall 75% in a little more than a month earlier this year. They've recovered nicely, a lot like the airlines, but they're still 43% down year-to-date. This is a company that was in a lot of, it was having a lot of challenges even before COVID, with 737 MAX, some other issues, they were on a new CEO as of December.
The good news for Boeing is they have done a very good job avoiding the worst. They've secured $25 billion in new debt which gives them plenty of liquidity, it gives them a lot of interest payments going forward for investors, but they're not going anywhere. They've reached some really important deals on deferrals where they're not going to see cancellations through their order book. Boeing is going to survive; they've been focused on survival. But, you know, they cut their dividend, they are cutting jobs, they too were saying this is going to be a multiyear process, and I believe them.
Sciple: You look at Boeing able to raise $25 billion in debt. You know, I look at a company that has that type of access to capital, I don't think they're going to close up shop anytime soon, with people lining up to give them cash. But whether Boeing is affected or not, some of its suppliers aren't necessarily as privileged as Boeing is when it comes to their balance sheet, confidence of investors, that sort of thing. Should we have any concern that poor financial condition of suppliers could affect Boeing negatively in the near term?
Whiteman: I can tell you that Boeing has that concern, so I think you should. Also, a lot of what Boeing has raised, knowing that they are going to need to support companies like Spirit AeroSystems, which is a former Boeing subsidiary that makes basically the frames of these jets. There's a lot of companies up-and-down the supply chain that, yeah, you're right, can't access that kind of capital and are reliant on Boeing.
Truthfully, this is an issue that predates COVID. If anything, the real thing that moves the needle here is the 737 MAX. Boeing has been bleeding money for a year now because they have not been able to deliver 737 MAXs. And their suppliers, they've continued to buy those supplies to avoid layoffs, to avoid this sort of disruption. Boeing burnt through $4.7 billion in cash in the first quarter. The biggest thing they can do to stop that is to get the 737 MAX flying again. That, more than anything that's happened with COVID, is what's going to stabilize Boeing. And that will trickle down through the supply chain just like the damage did. And that's really what you need to watch for; a whole range of companies that count on Boeing.
Sciple: And we've gotten some updates on the 737 MAX's status in the past few weeks; can you tell us about that, Lou?
Whiteman: So, they spent most of 2019 manufacturing jets, comically almost, running out of places to park them, because they can't deliver them. There's all sorts of great pictures of 737s just parked in the employee parking lot, because Boeing literally ran out of room and they can't put them in the air. They gave up on that end of last year, they had suspended production. Just at the end of May, last day of May, they restarted production at a low rate, they remain confident that even with COVID and even -- I mean, just the practicalities of having international regulators come to Seattle to do testing on it, has delayed the process, they are confident that it will be flying, it will be certified in the third quarter. You're not going to see it in airline schedules maybe till the beginning of next year, but that would be a big milestone in terms of Boeing's recovery would be to just get that certificate.
Sciple: Alright, get that inventory out of the parking lots and into the air and start recognizing some revenue on that, Lou, so --
Whiteman: -- Right. Not to mention, just to say, that is incredibly expensive just to keep these things parked, you have a lot of advanced electronics that need to be babysat, you have batteries -- it is very expensive, whether for the airline customers or Boeing, just having those things on premises, not flying. It's almost like telling people they should be checking the car battery with COVID, if they're not trying.
Sciple: So, we mentioned earlier, when it comes to these airlines, likely to be more conservative with their purchases of additional airplanes, going to probably delay some deliveries of Boeing aircraft. So, when we look at that part of the business, I think it's safe to assume that at least over the next three years or so, growth is going to be depressed, if there's much growth at all. When you look at the business here today, Boeing isn't only the airliner part of the business, they also have a defense part of the business. So, if we assume that this airline side of the business is going to be impaired over the next three to five years, is there enough there in the defense part of the business to support the company for three years or so?
Whiteman: To support, sure. But as an investor, it's nothing that's going to make you buy-in right now. Boeing's defense business has underperformed for a while now. And the Pentagon actually complained, Boeing, you're spending too much time on commercials. And for the Pentagon to say that publicly, they do not like to address their contractors in public like that.
To their credit, in the last couple of years, Boeing Defense has won some very important contracts. A new trainer jet is going to be a huge deal, they have a refueling drone, they have some other good wins. Those are all years away to really bring revenue, but it does support the business some.
But let's not kid ourselves, even last year, with no MAX deliveries, with the 737 MAX only an expense, basically, for most of the year, commercials was 42% of total revenue. 2018, which was much more of a normal year, it was more than half of revenue. This company survives, but this company thrives off of commercial, it has over the last decade plus, and it needs commercial back to really be the company that investors were buying into six months ago.
Sciple: So, is it fair to say, if you're investing in Boeing today, you need to believe in the airline recovery happening in a meaningful way in the next three years?
Whiteman: I do. And even then, I think there's probably better options, just because of Boeing's product mix. I think used planes come back a lot sooner. And there's better ways to play that, but, yeah, I mean, Boeing is not going away. If you have enough patience, you'll probably do fine, but it's pretty low on my list of ones that I want to personally own right now.
Sciple: Okay. When it comes to areas that might be a little bit more interesting, we had Jim Gillies, Fool analyst on the show about a month ago, and we talked a little bit about AerCap Holdings (NYSE: AER), that's ticker AER, that is an airplane leasing company. Lou, this is a company that you follow as well?
Whiteman: Uh-huh. This is an interesting company, and I think he's exactly right. This could be a really -- if you want to bet that travel doesn't go away, but you're a little afraid the airlines could at least go bankrupt and wipe out equity, AerCap is an interesting business.
This is part of the "Airlines 2.0," where they have reinvented themselves and made themselves healthier by keeping some of these huge expenses off of their books. AerCap buys planes and leases them, puts them into airline customers on a lease. So, they take the debt on their balance sheet. This is a dangerous business to be in, in a downturn, in theory.
And another one of the aircraft lessors, SMBC Aviation, the CEO, I think, was on CNBC earlier today, just saying, this is going to be a difficult time for this industry, and as you'd expect, their customers are in trouble.
But AerCap is a very well-run company, it's very conservatively run. They're going to be impacted by this. They have deferred some of their deliveries, I think, 37 planes that were scheduled to come in the next couple years, they're going to take in later years. They say that everything they're going to accept between now and the end of 2021 has a lease on it, which is a good sign, but, you know, subject to change. The important thing is, as of the end of the first quarter, they had $11 billion in available liquidity, they had $28 billion in unencumbered assets, if they need to mortgage things. They're going to make it; their stock has been hit hard too along with this.
As I said before, if you believe travel isn't going to go away, but you're not so sure that American Airlines is going to be there without a bankruptcy, this is a really interesting way to, sort of, be bullish on travel without trying to pick an airline.
Sciple: Yes. So, just fundamentally explaining what's going on, these airlines represent the equity side of the business, the equity side of the stake in the business. And AerCap, as the person who is leasing the equipment that the airline uses, really holds a claim on the debt side of the balance sheets of these businesses. So, it's one of these situations where if an airline goes bankrupt, as the lessor, it's not great for aircraft because its lease isn't going to get paid and they're going to have to repossess their property. But at the end of that process, AerCap is left with the valuable asset, which is these airplanes, whereas the airline, that equity may well go to zero.
Whiteman: Right. And it is, I mean, I wouldn't necessarily argue this, but just to make sure both sides are on there. The danger there is, is that if many airlines go bankrupt and suddenly it becomes that much harder to place things again, it's almost like the argument from the last recession, where housing won't all go down at once.
And it can happen. A global pandemic is just the sort of thing that, in theory, could ruin this business, because it's everybody globally having trouble at once. Again, in a worst-case scenario, the second wave is even worse than the first. They're going to need every bit of that liquidity they have available to them, but it's going to take a worst-case scenario for me to really worry about that.
Sciple: And there's another company who's been able to raise capital in this environment, really shore up their balance sheet, as well as, I think you mentioned just a minute ago, how they've restructured some of their deals to maybe deliver planes later, that sort of thing, to try to adjust for what's going in the market.
Whiteman: Yeah. No, they're a good company, and like I said, there's going to be a lot of other things that are in serious trouble by the time they are, but it could happen, it's worth mentioning the downside.
Sciple: So, if you had to take a flyer on the recovery in the airline industry today, would AerCap be the No. 1 way you'd go invest in that?
Whiteman: I think AerCap is the safest way. Yeah, I mean, the stock has slowly creeped up, it still looks cheap, but it was probably the best buy-in on Wall Street about a month ago, because it had lost -- I don't even have the numbers in front of me, how far they were down. I still think that's a pretty reasonable way, I mean, I have not bought any airline shares, but I have not sold any airline shares. And I still believe in the airlines that I'm still hopeful of the stocks I own. But, yeah, I think if someone is interested in this sector, AerCap is a really interesting way to look at it without taking on all of the risks of the individual names.
Sciple: I mean, from an evaluation point-of-view, it really looks reasonable. Obviously, you're taking some risk, given the lot of uncertainties in this market for airplanes, but we'll see how it goes. I think, given the price that you're paying, the risk/reward is certainly reasonable for the stock today.
So, Lou, as we zoom-out looking at the airline industry, where do you think we are three years from now?
Whiteman: Hmm ... I think, three years from now, hopefully, we're feeling pretty good about ourselves. I think, for the time being, especially in a lot of nonbusiness headlines going on right now, I think the next quarter or so is going to be the airlines almost tracking the broader markets, because the markets are trading based on good news and bad news about COVID. And I think you're going to see the airlines maybe taking a more pronounced jump; recently if the S&P is up 1%, the airlines are up 5%, and vice versa with the down.
Look out for a few years, I still believe that we aren't going to have any U.S. bankruptcies and I'm still hopeful that we're going to be well-off for lows. I mean, look, these companies are trading right now at less than 0.5X sales. Now, granted that's a backwards looking number and revenue is coming down, but if you believe in this industry and you believe that it can come back to where it was in a few years, to 1X sales or back to where sales were, there is a lot of room for these stocks to grow.
I think your choice right now is the trade-off between time and potential return. There are other industries that are going to recover faster, but I don't know if there are many industries that have the potential to really deliver returns that the airlines have right now. So, you know, choose your risk.
Sciple: You're getting paid to buy into that uncertainty.
Whiteman: Hopefully, yeah, I mean it just might take longer, you know, I think there is a time, cost, and money, right? But yeah, no, I mean, some of these better-run companies, there is real potential for those to be the sort of gains that you may see in tech sometime, but you don't normally see in an industrial line company.
Sciple: Yeah, time will tell. Still a lot of uncertainty in what the world looks like here a few years down the line, but we will be following it as it develops, and we hope to have you on again soon, Lou, to break it all down.
Whiteman: I appreciate it, I'll just come on.
Sciple: As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear.
Thanks to Austin Morgan, for making us sound so nice. For Lou Whiteman, I'm Nick Sciple, thanks for listening and Fool on!
