Just a few weeks ago, the global COVID-19 outbreak didn't seem to be hurting U.S. airlines much. Airlines suspended their flights to China and reduced capacity on some other routes to Asia in February, but a drop in oil prices was offsetting the impact of this disruption. As recently as Feb. 24, United Airlines (UAL 3.27%) -- which has by far the most exposure to China of any U.S. airline -- still expected to achieve its Q1 earnings guidance, which called for adjusted earnings per share between $0.75 and $1.25.
Unfortunately, the outbreak has turned into a full-blown pandemic in March. At the beginning of the month, there were only 70 confirmed cases in the U.S. By contrast, more than 200 new cases have been confirmed every day recently.
As a result, air travel demand has evaporated over the past two weeks. Not surprisingly, airline stocks have plunged in response, with many losing about half of their value in less than a month.
Monthly Airline Stock Performance, data by YCharts.
Let's take a look at how the COVID-19 crisis is impacting airlines like United, American Airlines (AAL 4.43%), Southwest Airlines (LUV 0.73%), Alaska Air Group (ALK 2.85%), and JetBlue Airways (JBLU) -- and whether investors should consider investing in any of them at today's discounted prices.
Demand is cratering and rules are changing
The first big impact of the COVID-19 outbreak on the U.S. airline industry was the suspension of all flights to and from China in early February. This followed a Trump administration order barring most foreign nationals who had recently visited China from entering the U.S.
As the pandemic has swept across the globe, airlines have canceled their flights to other key hotspots, such as Italy and South Korea. Even in the domestic market (and on international routes to countries with smaller COVID-19 outbreaks), there has been a sharp drop in demand, forcing airlines to reduce capacity where possible.
United Airlines has been the most forthcoming about what it is seeing. Earlier this week, United President Scott Kirby said that the airline has experienced a 100% decline in net bookings to Europe and Asia in recent days, with cancellations fully offsetting new bookings. Gross bookings (excluding cancellations) are down 70% in the Asia-Pacific region and 50% in Europe. In the domestic market, gross bookings are down 25% and net bookings are down 70%.
With demand evaporating, United now expects to post a loss in Q1. It is also planning for a dire scenario where revenue could plunge 70% in April and May and recover slowly in the months thereafter. (It doesn't see that as the most likely outcome, but it is within the realm of possibility.) As a result, United has cut domestic and international capacity 10% and 20%, respectively, for April. It expects to make even deeper cuts in May and won't start to restore canceled flights to its schedule until it sees firm signs of improving demand.
Other airlines have corroborated this general picture. For example, JetBlue CEO Robin Hayes recently stated that demand has plunged faster than the 30% drop seen immediately after the 9/11 attacks. JetBlue, Alaska, and Southwest all expect to miss their Q1 unit revenue forecasts by at least 5 percentage points, with all of the shortfall coming in March. And every major U.S. airline is cutting capacity, albeit not as radically as United.
Image source: Southwest Airlines.
Just in the past couple of days, the U.S. announced a 30-day ban on travel from Europe to the U.S., excluding U.S. citizens and permanent residents. Additionally, the FAA agreed to suspend "use-it-or-lose-it" rules for takeoff and landing slots at the three federally slot-controlled airports through the end of May. (Typically, airlines must use the slots at least 80% of the time to avoid losing them.) These developments will likely spur further flight cancellations.
In short, Q1 is shaping up to be a bad quarter for airlines, and Q2 will be much worse. Jet fuel prices have fallen by about $0.90 per gallon since the beginning of 2020 -- enough to offset a roughly 10% revenue decline for most airlines. Flight reductions and other cost-cutting measures could potentially offset another 10% to 20% revenue loss. But if airlines see a short-term revenue decline of up to 70%, there's no way they will be able to reduce their costs enough to remain profitable.
Balance-sheet strength is critical
The good news for airlines is that the steep plunge in demand they are experiencing right now isn't likely to last very long. There's a wide range of opinions among public health experts, but the pandemic could start to subside in as little as three months (as has been seen in China), or by sometime in 2021 at the latest. The key for U.S. airlines is being able to ride out a severe demand slump that is temporary but of unknown duration.
That means investors hunting for bargains in the airline industry should focus their search on the companies with the best balance sheets: Southwest Airlines, JetBlue Airways, and Alaska Air.
Image source: Alaska Airlines.
As seen in the slide above, Southwest and JetBlue stand out in the industry for the strength of their balance sheets. Alaska is a close No. 3, having reduced its debt-to-cap ratio to 41% by the end of 2019 -- 4 percentage points better than its position as of midyear. By contrast, American Airlines has by far the biggest debt load in the industry. It is one of the least profitable U.S. airlines to boot. While American has a substantial cash buffer, it could still suffer greatly if demand doesn't bounce back by the summer.
Additionally, Southwest Airlines, JetBlue Airways, and Alaska Air all have substantial cash balances. As of a week or two ago, they had $5.3 billion, $1.2 billion, and $1.6 billion in cash and investments, respectively. Including existing revolving credit facilities, Southwest has liquidity equal to 28% of its 2019 revenue. For JetBlue, the figure is 22%, and for Alaska it's 23%. All three airlines also have billions of dollars of unencumbered aircraft that they could mortgage if necessary.
In short, while Southwest, JetBlue, and Alaska could experience some near-term losses, they have ample resources to make it through the coming COVID-19 downturn. Importantly, they should be able to make it through without taking any actions that would impair their long-term earnings prospects.
A clear choice
Aside from having stronger balance sheets than their industry peers, Southwest Airlines, Alaska Air, and JetBlue Airways have the advantage of primarily serving domestic routes (and Latin America to a lesser extent). They have no direct exposure to Europe and Asia, the markets where demand has fallen the most.
Market conditions could change on a dime, but it's reasonable to expect domestic travel demand to continue faring better than international demand during the crisis. It also may recover more quickly after the rate of new cases starts to slow, as "visiting friends and relatives" traffic tends to be more resilient than business and leisure demand, and many travelers will be more comfortable committing to shorter trips initially.
Thus, while the COVID-19 pandemic will hurt Southwest, Alaska, and JetBlue, it doesn't pose an existential threat to any of them. By 2021 (or 2022 at the latest), they should be back to business as usual. And while they may lose money in the meantime, the scale of their losses is likely to be far smaller than the decline in their share prices over the past month.
As a result, shares of all three low-fare carriers look like great investment opportunities for patient investors willing to endure plenty of volatility in the weeks and months ahead. By contrast, American Airlines and United Airlines face a much greater risk of long-term damage, depending on the severity and duration of the COVID-19 air travel downturn.
