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Daniel Foelber

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Use this roadmap to invest in the airline sector right now.

Although the stock market is near an all-time high, there are still many sectors that remain below their pre-pandemic levels. One of those sectors is the airlines, which for months have been a fierce battleground between those who think the worst of the pandemic is behind us, and others who expect a prolonged slowdown in air traffic.

For everyone in between, airline stocks present a high risk/high reward opportunity in need of a roadmap. This article is meant to help you determine if buying or selling airlines is right for you, as well as what to look for when shopping for top airline stocks.

IMAGE SOURCE: GETTY IMAGES.

Performance

Since reaching their lows in early May, airlines have enjoyed a nice recovery, but are still down substantially for the year.

LUV DATA BY YCHARTS

As you can see, airlines are not all performing the same. There’s a big difference between the performance of Southwest Airlines (NYSE:LUV) and United Airlines (NASDAQ:UAL), and a lot of that has to do with varying degrees of financial strength.

Financial strength (or weakness)

The first main aspect to consider when you’re thinking about buying or selling an airline stock in this market is the strength of its balance sheet. In a time when air traffic and revenues are substantially lower than normal, it matters how strong a company is financially, more so than even how efficient the company’s operations are. Therefore, a company with a lot of cash and ample credit is preferred over even the most efficient airlines. This isn’t to say that operational strength doesn’t matter — it does — but it matters less in a crisis, especially one of this magnitude.

LUV DEBT TO CAPITAL (QUARTERLY) DATA BY YCHARTS

From a balance sheet perspective, Southwest Airlines is the best. This shouldn’t come as a surprise to those who have been following the industry for a while. Yet even Southwest is concerned, citing cost and spending cuts, an earnings collapse, and the need for government support even with its “fortress balance sheet.”

Another point to consider is the daily cash burn rate, which is the amount of cash an airline is losing every day. Many of the prior estimates from late April have been revised to reflect improvements to air traffic as states reopened their economies.

DATA SOURCES: SOUTHWEST AIRLINES, DELTA AIR LINES, UNITED AIRLINES, AMERICAN AIRLINES, ALASKA AIR GROUP, JETBLUE AIRWAYS, SPIRIT AIRLINES.

Some revisions have been staggering. For example, American Airlines (NASDAQ:AAL) was burning around $100 million per day in April. Although it has improved since then, the company’s cash burn is still among the highest of all airlines, and higher than that of Delta Air Lines (NYSE:DAL) and Southwest, even though they are around three times American’s size.

Even though nearly all of the major airlines have revised their April estimates to reflect less harmful daily cash burn, it’s still cash burn. There’s no sugarcoating that their businesses have gone from making money to losing money.

Alaska Air Group (NYSE:ALK) estimates that it can reach breakeven by the end of 2020. Delta estimates that it could reach breakeven by early 2021.

Another estimate that airlines are conveying to investors is how much cash they have on hand to handle an ongoing cash burn. Southwest forecasts that it has two years of cash on hand, based on its revised cash burn rate of $20 million per day.

It gets tricky once you realize how sensitive these estimates are. For example, Southwest’s cash will only go half as far if its burn rate increases to around its original April estimates. That could happen if the rise in COVID-19 cases in Texas, Florida, Arizona, and other states brings a second wave of shutdowns.

Digging deeper

Digging deeper into the cash burn numbers, it’s clear that some airlines are not taking the pandemic as seriously. For example, Delta and JetBlue Airways (NASDAQ:JBLU) blocked middle seats on their domestic flights, and Southwest has ensured that it will not book a single flight at more than two-thirds capacity. On the other hand, American Airlines was keeping planes at 85% capacity, but starting July 1, it resumed booking to full capacity, if possible. United and Spirit Airlines (NYSE:SAVE) also aren’t capping capacity. Therefore, although American has substantially decreased its cash burn estimates, that assumption is grounded in the fact that it isn’t restricting capacity on its planes.

It’s hard not to notice that the airlines with the loosest attitudes about capacity are also the ones that have the weakest balance sheets and whose stocks have been hit the hardest by the pandemic. Ignoring social distancing advice in an effort to maximize the revenue from a plane may help their short-term numbers, but it also could rub customers the wrong way or even dissuade passengers from traveling with these airlines altogether.

Pick what’s best for you

Airlines aren’t for everyone. If you have a long-term time horizon and believe that airline traffic bottomed in the second quarter, will gradually increase in the third and fourth quarters, and will return somewhat to normal next year, you should probably be a buyer of airlines. If you have a short-term time horizon, believe a vaccine could take a while to implement, and believe that there could be a second wave of COVID-19 cases that causes airline traffic to regress and stall at Q2 levels, you may want to sell airlines.

Even if you’re somewhat undecided, my advice would be to only consider the best of the airline stocks, which would be mainly Southwest and Delta, and maybe the small but strong airlines like Alaska and JetBlue. These companies could provide a strong long-term investment. With this comes a good amount of risk, but you’d be doing yourself a favor by backing only the best in the sector.

Author: Daniel Foelber

Source: Fool: Should You Buy or Sell Airline Stocks Right Now?

What Buffett’s sale means for Delta.

On Monday, Delta Air Lines (NYSE:DAL) fell within striking distance of its 52-week low after Warren Buffett announced the sale of Berkshire Hathaway’s (NYSE:BRK.A) (NYSE:BRK.B) entire stakes in Delta, Southwest Airlines (NYSE:LUV), American Airlines Group (NASDAQ:AAL), and United Airlines Holdings (NASDAQ:UAL).

Should you sell too, or are Delta shares a buy at this reduced price?

A misleading headline

Flashed across business and finance news outlets on Monday was the headline that Warren Buffett sold all his airline stocks. Although some outlets are guiltier than others with their packaging of this news, the headline could easily be misinterpreted as saying that Buffett sold all his airline stocks in one fell swoop or in a day or two, when in reality, the sale occurred gradually over the month of April. In fact, Buffett had already announced his sale of large portions of Southwest and Delta in early April. The Monday headline is certainly not good news, but it’s also not as dramatic as it seems.

Buffett’s take on the airlines

The Berkshire Hathaway Annual Shareholders Meeting typically attracts tens of thousands of visitors from around the world to Omaha, Nebraska to share in the wisdom of Warren Buffett. Held virtually this year, it was one of the most important events of the weekend as investors and admirers waited with bated breath to listen to the Oracle of Omaha’s first public remarks since the onset of the COVID-19 (coronavirus) pandemic.

“I hope I’m wrong,” said Buffett when discussing Berkshire’s airline purge. His melancholy tone reflected his sympathy for the industry. “The future is much less clear to me how the business will turn out for absolutely no fault of the airlines themselves.”

Warren Buffett was a longtime critic of the cyclical nature and capital intensity of airlines. That changed in 2016 when Berkshire purchased shares of four major airlines, one of which was Delta. Buffett then added more than five million Delta shares in 2019.

During the meeting, Buffett pointed out uncertainties that many travelers and investors are already thinking, namely that public perception has changed and people will fly less in the coming years. He also noted the oversupply and over-ordering of aircraft by major airlines, which seemed logical at the time but now is simply another weight on the industry’s wavering shoulders.

The Delta difference

A bit shocking to me and other Fools was Buffett’s full-on eradication of Berkshire’s entire airline position, including stronger airlines like Delta and Southwest.

Delta was arguably the best airline going into 2020. Both on a percentage basis and in terms of absolute values, Delta grew its net income and free cash flow (FCF) more than Southwest, United, or American Airlines over the past three years. In short, Delta has been the elite cash cow of the industry.

DAL NET INCOME (TTM) DATA BY YCHARTS

But as Buffett pointed out, times have changed for the airlines. Now, it’s all about financial strength and an airline’s ability to survive this crisis, which means determining if an airline has too much debt or is overly leveraged.

DAL DEBT TO CAPITAL (QUARTERLY) DATA BY YCHARTS

Although it’s not as solid as Southwest, Delta is getting a boost from the government bailout. “The agreement with [the] Treasury includes $5.4 billion from the payroll support program. The payment includes an unsecured 10-year low-interest loan of $1.6 billion, and Delta will provide the government with warrants to acquire about 1 percent of Delta stock at $24.39 per share over five years,” the company said.

The waiting game

Delta is an interesting airline stock because it doesn’t have the best balance sheet, but it has arguably the most upside if airline traffic improves over the coming quarters.

For now, Delta can do little more than wait. According to Delta’s first-quarter 2020 earnings release, the company expects June revenues to be down “90% compared to a year ago.” The company is “parking more than 650 aircraft,” and is “instituting a companywide hiring freeze and offering voluntary leave options with 37,000 employees taking short-term unpaid leave.”

Like all airlines, Delta will likely continue to struggle as preferences change toward flying. An investment in Delta is essentially a bet that the economy will slowly heal and people will once again be taking to the skies for business and personal trips. One of my biggest fears is that the widespread adoption of virtual meetings could lead to a paradigm shift that makes it difficult to justify face-to-face business meetings from a cost perspective. The fewer in-person meetings, site visits, plant visits, industry conferences, etc., there are, the less revenue there will be for the airline industry.

Survival of the fittest

This paradigm shift aside, Delta is one of the best U.S. airlines and has a proven track record of strong earnings and cash flow. The suspension of the company’s dividend and government aid are necessary measures to give the company as much cash as possible. Delta is flying straight into a series of headwinds that will test the company’s resilience to its core. With the stock down over 60% in 2020, I think a long-term investment in Delta is wise if the assumption is made that a rebound could take years. That being said, investors can take solace in knowing that Delta is one of the best-positioned airlines in a war of attrition where only the fittest airlines survive.

Author: Daniel Foelber

Source: Fool: Is Delta Air Lines Stock a Buy?

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