What happened
I've been saying for a while now that as long as the COVID-19 pandemic is dominating headlines airline shares are likely to trade as a group, focused on hints about future demand, rather than simply based on company-specific news. On Tuesday morning, we saw an illustration of this phenomenon.
On Tuesday shares of United Airlines Holdings (UAL 1.59%), American Airlines Group (AAL 1.51%), and Delta Air Lines (DAL 4.05%) all traded up more than 5% based on positive commentary from Southwest Airlines (LUV -6.96%), yet Southwest shares didn't climb as high as shares of its rivals.
So what
Airlines have been in a free fall due to the pandemic, with revenue down 80% or more year-over-year and customers refusing to take to the skies. The entire sector plummeted early in the pandemic, and in the months since, the stocks have largely traded in tandem based on positive or negative headlines surrounding the pandemic and how long it might take for travel demand to recover.
Image source: Getty Images.
A Southwest regulatory filing sparked a rally in airline shares on Tuesday. The company said it feels good enough about its liquidity and access to private capital to forgo a government assistance program its CEO had previously called "pretty onerous." Southwest also said it was seeing improved leisure demand in August and heading into September, helping it to lower its estimate for third-quarter average daily cash burn to $20 million from $23 million.
Southwest has a domestic-focused network, and for a decade now the airline has been among the leaders in leisure market share. But the markets on Tuesday are interpreting good news from Southwest about demand as good news for the entire sector, pushing its major rivals higher as well.
Now what
There are plenty of caveats to this bout of optimism. While Southwest is feeling good enough about its financial position not to take the government loans, others including American have indicated they do intend to tap the government for further liquidity.
And even if demand has improved slightly, the overall outlook is still bleak. Southwest expects third-quarter capacity to decrease by 30% to 35% year over year. That's worse than its previous estimate for a 20% to 30% decline. As summer ends some of that leisure demand is going to dry up. Southwest expects October capacity to be down 40% to 50% compared to 2019.
The good news is that thanks to the government loan program and private markets the entire industry has a substantial runway to withstand the worst of the pandemic without running out of cash.
The industry, given enough time, will recover, and I am optimistic domestic bankruptcies can be avoided. But the outlook is still far from certain, and the recovery will take time. For now, it is best for investors to focus on Southwest and other companies that are well positioned for the downturn and to avoid buying riskier names.
