Air travel demand is sagging again due to a surge in COVID-19 cases, but that doesn’t mean investors need to avoid all airline stocks.
Nov. 24, 2020
This article originally appears on The Motley Fool, written by Adam Levine-Weinberg.
The latest wave of the COVID-19 pandemic looks like it could be even worse than the initial outbreak that tore across the U.S. this spring. With the coronavirus rampaging out of control, airline bookings — already weak by historical standards — are slowing further. Meanwhile, cancellations are on the rise.
Last week, several U.S. airlines acknowledged the recent demand downturn, including American Airlines (NASDAQ:AAL), United Airlines (NASDAQ:UAL), and Alaska Air (NYSE:ALK). Does the latest setback mean it’s time to sell airline stocks? Or does positive news about vaccine development make it a good time to buy? Let’s take a look.
The pandemic takes a turn for the worse
As recently as the second week of September, the U.S. was reporting an average of just 35,000 new COVID-19 cases and 750 deaths per day, according to data gathered by The New York Times. About 30,000 people were hospitalized due to COVID-19 symptoms as of mid-September.
Unfortunately, all coronavirus-related statistics have moved sharply in the wrong direction over the past two months. The number of cases has nearly quintupled since mid-September, the number of hospitalizations has almost tripled, and the death rate has almost doubled.
Initially, the most recent uptick in COVID-19 cases didn’t stop a trend of gradual improvement in U.S. air travel demand. However, with the coronavirus seemingly spreading like wildfire and health officials urging people to stay home — and to avoid holiday travel in particular — it looks like the most recent leg of the air travel recovery is fizzling out.
A change in booking activity
The number of people passing through TSA checkpoints has held steady for the past six weeks (roughly speaking), following two months of gradual improvement. Despite the lack of sequential growth, most airline executives have been upbeat about demand for holiday travel. That, along with vaccine progress, has helped most airline stocks edge higher over the past few months.
U.S. airlines are now sounding a note of caution, though. In a Thursday SEC filing, United Airlines noted, “In the last week, ending November 18, 2020, there has been a deceleration in system bookings and an uptick in cancellations as a result of the recent spike in COVID-19 cases.” The same day, Alaska Air said that cash burn was likely to increase sequentially from October to November. “We believe that renewed restrictions by many state and local governments have negatively impacted demand in the immediate term,” the company stated. American Airlines’ management acknowledged similar trends at an industry conference.
Of course, there are still plenty of people willing to travel. But it seems increasingly unlikely that there will be a big step-change improvement in demand. Making matters worse, demand tends to be at its lowest during the first quarter. If anything, air travel trends could weaken again in the first two or three months of 2021.
Quality is still the key
So what does the recent change in demand trends mean for airline stocks? It depends on which airline you’re talking about. Airlines with strong balance sheets don’t have to worry too much about short-term trends. Obviously, it’s better to burn less cash than to burn more cash. However, stronger airlines can afford to take near-term losses, looking forward to a likely rebound in demand starting around the middle of next year, after COVID-19 vaccines become widely available.
For example, Alaska Air finished last quarter with nearly $3.8 billion of cash and investments and a manageable $5.4 billion of debt and lease liabilities. While it expects to burn between $125 million and $150 million in November, up from $97 million in October, near-term cash burn clearly won’t break the bank.
By contrast, American Airlines ended Q3 with $8.3 billion of unrestricted cash and investments but a staggering $41.2 billion of debt and pension liabilities. Its initial Q4 forecast implied that it would burn another $2.5 billion or so this quarter. The airline has issued shares several times this year, significantly diluting American Airlines stock owners while only covering a fraction of the company’s cash burn. For American Airlines, every additional dollar burned in the months ahead will make it harder to recover.
American Airlines and United Airlines face two additional burdens. First, they have high cost structures. Those costs help them attract business travelers during normal times, but most industry officials expect business travel demand to recover very gradually. Second, both airlines — but especially United — have high exposure to long-haul international travel: another market segment that is widely expected to recover slowly.
Thus, the recent setback for air travel demand isn’t a reason to sell all airline stocks. However, investors would probably be better off holding shares of higher-quality airlines like Alaska Air while avoiding shares of more troubled names like American Airlines and United Airlines.
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