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Airline Stocks Have Been Turbulent. Here Are 3 That Can Soar

By Lou Whiteman, Rich Smith, and Rich Duprey – Aug 14, 2021 at 7:00AM

Key Points

  • Southwest's industry-based balance sheet will help it to fly through whatever challenges lie ahead.
  • Cash is king in any economy, and Alaska Air Group is generating a lot of it.
  • Don't overlook air cargo carriers and the critical role they play in the global economy.

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It's been a difficult few years for airlines. But turbulence can create opportunities.

The airline industry can't seem to navigate away from trouble right now.

Stocks plunged last year as the pandemic hit, with investors rightfully concluding that COVID-19 would crimp travel demand and send airlines into the red. But the U.S. industry weathered that storm relatively well, and stocks began pushing higher late last year as the vaccine rollout gained traction.

This summer there have been new headaches. Demand has returned faster than airlines can rebuild their schedules, often causing cascading delays. Spirit Airlines is the latest to be making headlines for mass flight cancellations, but issues have plagued carriers including Delta Air LinesAmerican Airlines Group, and Southwest Airlines (LUV -0.82%) at various points this summer.

Quite frankly, the industry is a mess right now. But for long-term investors able to stomach some near-term turbulence, there are some attractive opportunities among these stocks. Here's why three Fool contributors are bullish on Southwest, Alaska Air Group (ALK -1.50%), and Atlas Air Worldwide Holdings (AAWW -0.31%).

A plane soars above the clouds.

Image source: Getty Images.

In times of uncertainty, fly with the leader

Lou Whiteman (Southwest): At first glance, this would appear to be an odd time to recommend Southwest Airlines. After all, the company just days ago slashed its guidance due to a slowdown in bookings and an uptick in last-minute cancellations.

But the reasoning behind the guidance change is not unique to Southwest. It was driven by the rapid spread of the delta variant. And Southwest more than any other U.S.-based carrier is set up well to handle whatever comes next. Given the growing uncertainty surrounding the pandemic, it is a good time to fly with the most stable airline.

Southwest expects revenue to fall by 15% to 20% in August relative to 2019, worse than its previous projection of a 12% to 17% decline and down from a July 12% fall. For the third quarter, the airline expects revenue to decrease by 15% to 20% compared to 2019.

The airline is the first to cut third-quarter guidance, but I'd be shocked if Southwest is seeing booking patterns that its competitors are not. The end of the summer travel season was likely to hit airline revenue hard even absent a new spike in COVID-19 cases. The added twist of the delta variant is almost sure to mean flights will be less full in the weeks to come.

Southwest throughout its history has won by being aggressive when others were retrenching, and the airline is set up well to do so again should conditions worsen. The airline has the industry's best balance sheet, with financial debt totaling just 0.36 times equity. Alaska is not far behind, at 0.4 times equity, but major competitors like American and United Airlines Holdings have debt totals that are more than twice their total equity.

Southwest is already investing during this moment of weakness, in June announcing a beefed-up order for new Boeing planes.

If the delta variant ends up just a temporary speed bump and travel demand rebounds in the months to come, Southwest with its leisure-focused route network and low costs is set up well to win. If it isn't just a speed bump, and we see a new crisis, there is no better airline to bet on during a downturn. Whatever happens from here, Southwest is the best airline to climb aboard right now.

Off its lows, this airline stock remains a bargain

Rich Smith (Alaska Air Group): Maybe I just lack imagination, but it still seems to me that Alaska Air Group is one of the best bets on airline stocks in any market -- and perhaps the best of all in a pandemic market like this one, wherein vacation travelers might be expected to prefer travel destinations with a bit more elbow room.

Consider: In Alaska's second-quarter earnings report last month, the company reported a big bounce back in revenue from Q2 2020, and a big $3.13-per-share profit, too, when calculated according to generally accepted accounting principles (GAAP). Revenue isn't quite back to pre-pandemic levels just yet, true, but it's heading in the right direction. Profits -- albeit still bolstered by government assistance -- were the best Alaska Air has seen since before COVID-19 was a thing.

An Alaska Air plane in flight.

Image source: Alaska Air Group.

As travelers get more comfortable flying, I expect things to continue improving for Alaska Air. So far at least, management says it hasn't seen any softening of demand trends despite the arrival of the delta variant of the coronavirus, and it's anticipating it will remain profitable through the end of this fiscal year at least.

And valuation-wise, I still see Alaska Air as top of the heap. Free cash flow for the last 12 months was a solid $312 million, with free cash flow in the first half of 2021 alone surging past $900 million. If Alaska can repeat that in the year's second half, we should be looking at a $7.4 billion stock ($8.1 billion net of debt) selling for just 4.1 times current year free cash flow (4.5 times with included debt).

At a stock price 8% below where it traded just before the pandemic hit, Alaska Air stock still looks like a bargain to me.

Forget vacationers, bet on a continued economic rebound instead

Rich Duprey (Atlas Air Worldwide): I'm not the biggest fan of airline stocks, but I recognize the value of getting from point A to point B quickly. That applies equally well to cargo. It is essentially the same business as commercial airlines, but with boxes instead of passengers, and I believe that's a bigger, better growth opportunity for investors.

Atlas Air Worldwide is a leading carrier in that regard and is a contractor for Amazon, which also partially owns the cargo aircraft operator and has warrants that could give it just under a 40% stake in the company. Helping Amazon to deliver the billions of packages it ships each year has been rewarding for Atlas, especially during the height of the pandemic, but it is continuing today.

Global air freight volumes exceed pre-pandemic levels and are forecast to hit $4.2 trillion this year, and Atlas president and CEO John Dietrich says economic and supply chain conditions remain favorable for air cargo carriers because demand "continues to exceed available supply, particularly on long-haul international routes, as belly capacity on a significant number of widebody passenger aircraft remains out of the market."

There is risk, as Amazon could pull its business from the carrier, and it's no surprise Amazon is building out its own air cargo fleet. But Atlas Air Worldwide operates the world's largest fleet of 747 freighters that count as customers express delivery carriers like DHL (which it operates a joint venture with), the U.S. military, freight forwarders, commercial airlines, and more.

Air cargo is a necessary and growing component of the global economy more so now than before and Air Atlas Worldwide offers the lowest valuations of any of its peers trading at just seven times estimated earnings and a fraction of its revenue, making the stock one investors could see take flight in their portfolios.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Rich Smith has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon and Spirit Airlines. The Motley Fool recommends Alaska Air Group, Delta Air Lines, and Southwest Airlines and recommends the following options: long January 2022 $1,920 calls on Amazon and short January 2022 $1,940 calls on Amazon. The Motley Fool has a disclosure policy.

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