Airline stocks are currently stuck in a holding pattern.
Shares of U.S. airlines have rebounded off their spring COVID-19 lows, but are still down big for the year as the pandemic continues to depress travel demand. The industry has scrambled to cut costs and fly through the turbulence, but at this moment there is a lot more fear surrounding the sector than greed.
Warren Buffett famously advised to be greedy when others are fearful, but then again he joined the stampede for the exits and sold his airline stocks due to the pandemic. So what's an investor to think about the airlines right now?
Here's a look at where things stand with the industry.
The case to buy airline stocks now
For all the issues the industry faces today, there hasn't yet been a U.S. airline bankruptcy. That's unusual for the airline business, where historically we've seen Chapter 11 bankruptcy protection filings, and occasional liquidations, whenever the economy went south.
But the industry entered this crisis in far better health than it has been in decades, and carriers have been able to raise billions in new cash to help offset the tens of millions of dollars they're burning through daily. U.S. airlines have raised about $50 billion in debt and equity financing, coupled with a similar amount of government assistance.
The result is an industry that has done a remarkably good job of stabilizing itself in a difficult environment. The airlines will likely report substantial losses through the remainder of 2020, at least, but even the weaker carriers have enough cash and levers to pull to make it well into 2021 before facing liquidity issues.
Image source: Getty Images.
The cost-cutting is not done yet. Three of the nation's largest airlines have announced plans to cut thousands of jobs in October as government assistance dries up. Expect the entire industry to be much more focused coming out of the pandemic, as management teams use the crisis to overhaul their businesses.
With the airline stocks all still down 25% or more for the year, the sector looks like good value assuming the airlines survive the crisis and eventually normalize.
The case to sell airline stocks now
Even if the airlines survive, the business is going to be ugly for some time to come. Traffic bounced off of spring lows as the summer went on, indicating there is some pent-up demand for travel, but according to Transportation Security Administration statistics domestic passenger numbers in August were down 70% year over year.
August was probably the high point. With many large employers still teleworking, business travel is sparse, and vacation demand will die down as schools restart. Expect demand to remain minimal until there is a widely available COVID-19 vaccine, which isn't likely until spring of 2021 at the earliest, and for business travel to remain sluggish even after there is a vaccine.
All told, it will likely be 2022 at the earliest before travel volumes return to pre-pandemic levels. Assuming it will take concrete signs of a recovery to get airline stocks airborne, buying into the sector today likely means watching other parts of the economy take off while the airline stocks remain grounded.
Image source: Getty Images.
The companies will also be badly bruised by the pandemic. American Airlines Group (AAL -0.21%), for example, entered the crisis with an industry-high debt load and has only been able to survive because it was able to raise significant amounts of cash. The borrowing spree has left American with more than $1 billion in annual interest payments.
Even when travelers take to the skies again, airlines will be using whatever free cash they generate to rebuild their balance sheets and have little left for shareholders or for growth initiatives.
Should you buy or sell?
I think airlines can survive without bankruptcies, and the stocks are safe to own. But given the risk, they are best limited to a small part of a well-diversified portfolio.
If you are going to buy, it's best to focus on winners instead of just buying a sector exchange-traded fund and gaining exposure to the weak and the strong. Avoid the most beaten-down names and focus on quality companies with the best balance sheets.
Southwest Airlines (LUV -0.35%) is the safest pick among airlines, but Delta Air Lines (DAL 0.40%) and Alaska Air Group (ALK -0.24%) both look like clear survivors, too, as the airlines try to chart a course post-pandemic.
