The COVID-19 pandemic has caused air travel demand, and airline stock prices, to plummet. And there's little reason to believe conditions will improve anytime soon.
That said, air travel isn't going to permanently disappear. And with the stocks off about 30% and 60% year to date, the sector is attracting interest from some investors looking for bargains.
I'm bearish on airlines over the next year, and bullish on them over the next decade. Exactly where they will be in the recovery process five years out is much harder to say. But here are three predictions about what commercial aviation will look like in 2025 for those weighing buying in to the sector.
COVID-19 will still be front of mind
Hopefully, by 2025 COVID-19 will be in the past, and although it is likely to take years for travel demand to rebound to pre-pandemic levels, most forecasters are optimistic it will not take five years.
Still, expect the scars to be visible on airline balance sheets. The U.S. airline industry has taken on more than $50 billion in new debt so far in 2020, according to Cowen & Co., and airlines are still raising cash. Add in a similar amount of government assistance -- some loans, and some backed by stock warrants -- and it is highly likely that much of whatever free cash flow the industry is generating in 2025 will be earmarked for debt reduction.
Dividends are unlikely, and stock buybacks will be limited at best. The airlines will hopefully by 2025 be in a position to take deliveries on some new planes, especially on orders where there is a penalty to pay if they do not take delivery, but few will be focused on expansion.
Investors need to view the airlines for the next few years as if they are patients recovering from serious injury. We're still in the triage phase now, but even when that is over there is still a long, painful period of rehab and recovery up ahead.
Airlines will be more focused
The decade leading up to 2020 was dedicated to empire building, with major U.S. airlines coming out of the last downturn restructured and looking to grow. That led to a series of mergers, and the survivors eager to one-up each other to try to offer the most expansive route networks by flying into second-tier international markets.
As mentioned above, debt will likely limit growth in the years to come. But I also expect management teams post-COVID to reboot entire parts of the operation, using the crisis as a reason to prune parts of the business that underperform.
"That's going to make us much more efficient as we come out of this, and we're excited about that," Parker said. "We're going to add back only what makes sense. We'll come through it more efficiently. I'm looking forward to that day when we're through all this, and we have that advantage."
Post-crisis I expect large, networked airlines American, Delta Air Lines (NYSE:DAL), and United Airlines Holdings (NASDAQ:UAL) to lean more heavily on international partners to provide global coverage, and for the entire industry to move away from trying to be a one-stop-shop for all travelers.
Fliers and investors will have new options
We are yet to have a domestic airline bankruptcy this year, and I'm optimistic that companies have raised enough cash to remain solvent through an extended downturn. Still, I'd be surprised if the landscape looks the same in five years as it does now.
Mergers among the so-called "Big Four" -- American, Delta, United, and Southwest Airlines (NYSE:LUV) -- would likely be blocked because those airlines combine to control 80% of U.S. traffic. But a reshaping of the industry is still possible.
For example, in 2020 American has partnered with both JetBlue Airways (NASDAQ:JBLU) and Alaska Air Group (NYSE:ALK) to fill gaps in its network. The company and its current management team both have a history of using M&A to consolidate. Elsewhere, discounters Frontier Airlines and Sun Country Airlines are both currently owned by private equity firms who will want to monetize their investments in the next five years, either by selling or via initial public offerings.
Expect new airlines to begin flying as well. Prior to the pandemic, Breeze Airways, led by JetBlue founder David Neeleman, had been preparing a launch. With COVID-19 leaving a glut of aircraft parked and available, other entrepreneurs and investors are likely to pounce at the first sign of a recovery.
What investors should do now
Assuming the airlines survive, there are opportunities for outsized gains from current share prices. But those gains will likely take years to materialize. Investors with a tolerance for risk should not avoid airlines, but also should keep them a small part of a diversified portfolio.
Be warned that the industry in 2025 will likely look different from today, and focus on companies best positioned to take advantage. I like Delta and Southwest because of their relatively healthy balance sheets, and because management at both companies have a good track record of innovating. Just be aware upon boarding that the destination is a long way off.