The airline business has been devastated by the COVID-19 pandemic, which caused travel demand to fall to near zero in March and April and has forced airlines to lever up to avoid bankruptcies. The industry expects second-quarter revenue to fall by up to 90% year over year, and airlines are warning it will take years for their schedules to recover to pre-pandemic levels.
Investors, including Warren Buffett, have dumped airline stocks and headed for the emergency exits. And months into the pandemic, cases are continuing to spike in some parts of the U.S., creating uncertainty about a possible recovery.
There are good reasons for investors to avoid this sector entirely, but for those tempted to be greedy when others are fearful, it's best to stick to top performers instead of buying a basket including both the industry's top, and riskiest, companies.
Of all the U.S. airlines, Southwest Airlines (NYSE:LUV) and Delta Air Lines (NYSE:DAL) are the most intriguing investment opportunities. Here's a look at both companies to try to determine which, if either, is a better buy today.
Southwest: More stable than most
Southwest has long been an investor darling for its ability to make money in good times and bad. It's the only major airline that has never flown into bankruptcy, and perhaps more impressively the company has never had to resort to furloughs or layoffs.
Management has warned the no-layoff streak might not last through year's end, saying the COVID-19 pandemic has been worse for the industry than even the attacks of Sept. 11. Still, Southwest has the wherewithal to survive.
In a mid-June regulatory filing, the airline said that it has raised about $16 billion year to date and has enough cash on hand to survive for two years at current burn rates. Southwest expects cash burn to fall over time, either through increasing revenue or cutting costs, but even if conditions worsen, the airline estimates it has about $12 billion in unencumbered assets to borrow against.
Southwest's network is well suited to benefit as traffic recovers. The company flies primarily domestic routes, which should see demand return before international routes, and the airline has strong exposure to tourism and other nonbusiness travel. In a typical recession, leisure travel returns before business because leisure is more easily stimulated by lower fares. Southwest has historically been a discount leader and can make money at fare levels where others cannot.
Southwest has also been more surgical in the flights it has cut in response to lower demand, and with more inventory available likely has better insight into day-to-day demand trends. The airline is well positioned to take market share during the downturn and come out of it in better shape than most.
Delta: Revamping the industry
Delta is one of the traditional airlines; it has suffered through a past bankruptcy, and in good times generates a sizable portion of its revenue from international fares. But among the so-called legacy airlines, Delta is the best-run company and has the strongest balance sheet.
The airline has been one of the industry's principal innovators since it emerged from bankruptcy more than a decade ago, revamping pricing to better compete against Southwest and other discounters and taking a scalpel to costs.
Some of those innovations have worked against Delta during this downturn: Prior to the pandemic, Delts committed billions to invest in foreign partners and lock up international alliances, only to see some of those partners fall into bankruptcy. But even with those investments, Delta came into this crisis with less debt than major airline rivals and significant financial flexibility.
Delta is currently burning through about $30 million in cash per day, but that's down from $100 million at the height of the crisis. Airline management believes it can reach breakeven by early 2021 at the latest, either through improving demand or cost cuts.
Delta has raised more than $8 billion year to date, at rates far better than what other airlines have had to pay for new debt. Management hopes to have $10 billion in liquidity at year's end, and like Southwest has more than $10 billion in unencumbered assets that can be tapped if conditions worsen.
The bull case on Delta isn't just that the airline will survive; it is that management will be able to use this crisis as an opportunity to further rethink the business. Gone are the days of global empire builders, when airlines flew to far-off, and potentially unprofitable, destinations just to fill out the route map.
Just as Delta a decade ago tore up the playbook on how airlines priced tickets, and in doing so created a much more stable, profitable industry, Delta post-pandemic is likely to lead the way in figuring out how to work with partners to provide global connectivity profitably and react to any permanent changes in business demand.
And the better buy is...
These are arguably the two best-run U.S. airlines. Nothing about the airline business is certain at this moment, but Southwest and Delta are as close to a sure bet as you can get. Those who want to take a flyer on an airline recovery should stick to a small position in a broader portfolio, but there are no better airline stocks to consider than these two.
I feel confident recommending either airline right now, and Southwest with its stellar track record of managing through crises and rewarding shareholders is the safer stock. But it is also not the bargain that Delta is. Shares of Southwest are down "only" 40% year to date, compared to Delta's 54% decline. Delta trades at 0.38 times sales, compared to Southwest's 0.78 times sales multiple.
Given I am just as confident that Delta will survive as I am Southwest, I'll take that discount. For my money, Delta is the better buy right now.