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The pandemic can’t end soon enough for airlines, but investors have priced the carriers’ shares as if the end is in sight.
Airline stocks have climbed sharply as vaccine approvals have lifted hopes for travel, and they are no longer bargains. The sector has gained 39% since early November, versus 13% for the S&P 500. While a few stocks look appealing as longer-term bets, investors might need to ride out some turbulence.
Airlines have hardly found their wings. Domestic travel is hovering at 35% of prepandemic levels, while international is down more than 80%. A $15 billion cash infusion from Washington, part of the new stimulus package, would help cover payrolls and avoid more furloughs at companies such as
American Airlines Group
(ticker: AAL) and United Airlines Holdings (UAL). But most of the carriers are still racking up daily operating losses, and booking trends have weakened for winter travel as the pandemic reaches new heights, triggering new lockdowns, quarantine rules, and restrictions on international travel.
The path to profits runs through an economic revival in 2021 and beyond, and the stocks are trading on 2022 estimates. That’s good and bad for investors. The positive is that 2021 is looking more like a bridge year; even if travel recedes a bit this winter, pushing down revenue and forecasts, the stocks should be supported if estimates hold up for the latter half of the year and 2022.
The negative is that the shares are priced for a V-shaped recovery, striking some analysts as overly optimistic. JPMorgan’s Jamie Baker recently downgraded almost the entire sector to Underperform, arguing valuations look full. Deutsche Bank’s Michael Linenberg cut ratings on all the stocks from Buy to Hold in December.
Consensus estimates are pricing in a recovery to more than 80% of 2019 revenue in 2022. But there is a big unknown: how much business travel goes permanently online. Domestic carriers need higher-margin business fares to improve their revenue yield per flight. And the capacity levels, profit margins and route structures of the “hub-and-spoke” international carriers rely heavily on business and first-class fares.
Still, there is a bullish long-term case. Airlines have slashed operating expenses, creating a lower cost base on which to rebuild revenue. While balance sheets are more bloated debt, adding $70 billion industry-wide, and equity has been diluted as the industry recapitalized, cash and liquidity are now high enough that insolvency no longer poses an imminent threat. The long-term outlook for margins is looking up, assuming that the carriers stay disciplined about restoring capacity and avoiding price wars.
Here are five stocks to consider.
E=Estimate
Sources: Bloomberg; FactSet
Delta Air Lines
(DAL) is a play on business and international travel coming back. The airline is expected to earn $3.6 billion in pretax income in 2022, with a 10% margin on revenues, more than double United’s. Delta has amassed $25 billion in cash and liquidity, and it has one of the strongest trans-Atlantic route structures, including flights out of its hub in Atlanta, the busiest airport in America. Citigroup’s Stephen Trent rates it a top pick. Going for nine times 2022 earnings, the valuation isn’t as stretched as the low-cost leisure carriers’.
Southwest Airlines
(LUV) is the strongest domestic carrier. It should benefit from the return of the
Boeing
(BA) 737 MAX plane to service; Southwest has 34 of the highly fuel-efficient planes and has orders for another 48 to be delivered. The carrier’s balance sheet is ironclad and should support higher capacity, including 18% gains in 2021 and 29% in 2022, according to Raymond James, which expects the airline to gain market share. Southwest could also capture more business fares, now that it’s participating in global distribution platforms for corporate tickets. Investors pay a steep price for its strengths, however. Its shares trade at 15 times 2022 earnings per share, well above the industry average.
Allegiant Travel
(ALGT) is an ultra-low-cost carrier, targeting small and midsize cities, vacation hotspots like Florida, and its home market of Las Vegas. Allegiant also sells vacation packages with hotels and car rentals. It’s expected to turn a small operating profit in the fourth quarter, well ahead of other carriers, and margins could beat current estimates as Allegiant buys more used planes at bargain prices. Its shares trade at 14 times estimated 2022 earnings, however, putting the stock in pricey territory.
Ryanair
(RYAAY) and
Gol Linhas Aéreas Inteligentes
(GOL) are bets on recoveries in Europe and Brazil.
Ireland-based Ryanair could be walloped by near-term headwinds, including trade frictions between the United Kingdom and European Union, and bans on U.K. flights due to the new strain of Covid-19. But Ryanair’s low-cost operating model and strong financial position should help it capture market share as travel recovers. The carrier is adding MAX planes to its fleet and says they’ll be a “game-changer” with 4% more seats and 16% fuel-economy gains over older aircraft. This winter will be rough, with capacity down to 40%, but the company aims to operate flights at 70% of available seating to squeeze out operating profits. At 16 times 2022 earnings, the stock trades in line with those of peers in similarly strong positions.
Brazil’s air traffic is running well ahead of other countries’ and Gol is capturing a large chunk. Half its revenue comes from the São Paolo region that is leading Brazil’s economic recovery. The airline is operationally break-even and could double revenue by next July, estimates Seaport Global Securities analyst Daniel McKenzie. He calls the stock “a great recovery play on Brazil” and maintains a $15 target on the American depository receipts, implying gains of 58% from recent prices around $9.50. The stock isn’t cheap at 20 times earnings. If the Brazilian real keeps rising against the dollar, however, it would sweeten U.S. shareholders’ returns.
Write to Daren Fonda at [email protected]
