Airline stocks are bearing the brunt of the markets' coronavirus fears.
That makes sense, to some extent. Global health fears and events such as the 9/11 attacks have, in the past, sent airline traffic plunging, and people on planes, after all, is the lifeblood of the industry. Travel always bounced back, but not before airlines started to buckle under the weight of their debt loads.
But investors might be using an old playbook to trade the sector. The stocks are trading at distressed levels, but the sector isn’t losing money, yet. That is something for investors to consider as they weigh how bad the coronavirus will hit consumers’ travel plans. And while others are keeping their distance from the industry, this could be a time to buy for when things do eventually turn around.
After all, today the sector is more consolidated and profitable. And debt compared with earnings for the sector is in line with other industrial companies. But the price-to-earnings ratios that investors pay for the stocks don’t reflect the improvement. The sector trades for 6.4 times estimated 2020 earnings, a huge discount to the S&P 500 (.SPX) multiple.
Many backward-looking financial metrics, such airline load factor and profit margins, look good, but the problem is what happens next to traffic—and right now, traffic is declining, rapidly. Travel declines are what pushed Buckingham Research analyst Daniel McKenzie to downgrade seven airline stocks Thursday. “Until we can get our arms around what demand and revenue will ultimately look like, we’re stepping to the sidelines,” wrote the analyst in his research report.
Airline stocks are already down about 21% year to date, on average, far worse than the decline of the Dow Jones Industrial Average (.DJI). McKenzie, however, slashed his price targets by about 50%, on average Thursday. He believes things could get worse before they get better.
“The downgrades are data-backed,” McKenzie tells Barron’s. He points out that bookings from Asia to the U.S. have collapsed in recent weeks and believes that pattern could be repeated from Europe to the U.S. if reported coronavirus cases continue to grow across the Atlantic. The industry can lose money if the shock is severe enough.
How bad does it have to get, traffic-wise, for airlines to lose money? It’s hard to say. McKenzie models profits for the sector in 2020, but there is still a lot of uncertainty surrounding all Wall Street airline earnings estimates.
Some international airlines have started cutting costs in preparation for the virus’s impact, The Wall Street Journal reported this week. U.S. airlines could follow suit.
Airlines used to publish break-even load factors—the percentage of seats an airline needs to sell on planes to avoid losing money. The figure fluctuated because of changes in ticket pricing and fuel prices, and airlines stopped giving the number because, probably, it wasn’t useful for investors.
They also probably stopped giving it because the sector started making more money. Southwest Airlines (LUV), for instance, has never produced an operating loss in any quarter. It also never gave break-even load factors.
The last time Delta Air Lines (DAL) reported its break-even load factor was around 2006—it was about 78%. Things are better now, and industrywide load factors are running at about 84%. That is something for investors to weigh. To make an educated guess, it would probably take a 15-percentage-point decline in traffic to produce losses. If declines of that magnitude are on the horizon, then investors should stay away. If it isn’t likely to get that bad, then it’s time to consider buying.
It’s a hard equation to balance.
“Risks” to Buckingham’s downgrade are a cure for the virus or if the outbreak is “short-lived.” Those are risks to missing out on a rally in airline stocks—but McKenzie would welcome better news on the virus front.
|For more news you can use to help guide your financial life, visit our Insights page.|