26 BARRON’S March 16, 2020
A
re airline stocks investible?
On a price/earnings basis
they appear cheap—Delta
trades at 5.6 times earn-
ings, while United and
American go for less than
four times earnings. But
airlines have been cheap for the en-
tire bull market, so those numbers
really don’t matter. “With the positive
airline story uncertain or even bro-
ken, there likely is no supportive val-
uation metric for investors,” says
Helane Becker, a veteran industry
analyst with Cowen. She recom-
mends staying on the sidelines until
there’s evidence that the virus threat
is receding.
So what should investors look at
instead? We looked to the bond mar-
ket for a possible answer. While air-
line bonds have sold off, as of Friday
afternoon, none of their unsecured
debt was trading at levels that signal
severe trouble ahead. “The debt mar-
ket is calling them stressed,” says
Barry Kupferberg, managing partner
at Barkers Point Capital Advisors.
“Not distressed.”
Barron’sperformed a stress test on
the airlines, looking at unencumbered
assets (any property like planes or
real estate that the airline owns out-
right), credit facilities, available cash,
and profitability. Scores range from
below five to 30. You would need an
iron constitution to take a flier now,
but the results lead to a couple of
stocks to consider—especially South-
west and Delta—and a few that could
keep investors up at night if the coro-
navirus, and economic, situation
takes a turn for the worse.
Southwest Airlines (LUV)
Financial Flexibility Score: 30,
Highest
Southwest’s stock has dropped 24%
this year, less than any other U.S. car-
rier. There’s a reason for that—its in-
dustry-leading balance sheet. The
low-cost airline has $5.3 billion in cash
and short-term investments available,
plus a credit line of $1 billion. Its long-
term debt/Ebitda (earnings before
interest, taxes, depreciation, and
amortization) ratio sits at a comfort-
able 0.7 times. Bernstein analyst Da-
vid Vernon estimates that Southwest
has $23.3 billion in untapped liquidity
at its disposal, enough to last quite a
while. Southwest has the least amount
of debt, just $4 billion compared with
$17 billion at Delta.
Still, expect it to take a revenue hit.
On March 5, Southwest estimated a
$200 million to $300 million drop in
sales from the virus, and has provided
no update since. The total impact is
probably worse. Earnings growth,
already challenged, will also take a
shot. The good news: Southwest has
the industry’s longest record of annual
profitability—it was profitable even
after 9/11—and it’s a good bet that the
carrier will make it through this crisis.
Southwest certainly thinks so.
“While it is difficult to estimate the
duration and severity of the impact
from Covid-19,” Southwest said in a
March 5 filing, “the company remains
financially strong.”
Delta Air Lines (DAL)
Financial Flexibility Score: 28,
Second Highest
Delta is another airline to have an
CRISIS PLAYBOOK
AirlinesNotYetaBuy.
Here’sWhattoWatch.
Air-carrier stocks have been cheap throughout the bull market. Global travel restrictions
due to the coronavirus have made them cheaper. Here are some key metrics to track.
Spencer Platt/Getty Images“The debt
market is
calling
[airline
bonds]
stressed,
not
distressed.”
Barry Kupferberg,
managing partner
at Barkers Point
Capital AdvisorsBy NICHOLAS JASINSKI
and AL ROOT
Asia are down 100% from the time
before the virus started spreading.
United is planning for a “dire sce-
nario” in which revenue collapses by
70% in April and May, and then ta-
pers off to a 20% decline inNovem-
ber and December.
“I suspect that’s shocking to some
of you, and for what it’s worth, we
don’t think it will actually be that
bad,” said J. Scott Kirby, United’s
president and incoming CEO, at a
conference this past week (held re-
motely because of the virus). “But
United is going to plan for a severe
scenario and make sure that we can
weather even that storm.”
Beyond slashing flights and
routes, airlines can pull more levers
to cut costs. They could pare their
fleets to reduce maintenance and
operating expenses. Labor costs can
be cut by firing or furloughing em-
ployees, cutting back on training, or
offering buyout packages. (The CEOs
of United and Southwest are taking
salary cuts, and the CEO of Delta is
forgoing his salary for six months.) If
all that isn’t enough, airlines can shed
assets, including international gates,
slots, and company-owned aircraft,
and they could default on lease pay-
ments for planes. Indeed, they now
have far more unencumbered assets
than they did before the industry
consolidated, giving them more flexi-
bility to add leverage, Vernon says.
The Outlook
So what’s the industry outlook?
Under Vernon’s worst-case scenario,
air travel starts to recover after four
to five months. That would wipe out
2020 earnings before interest and
taxes (Ebit) for the big three U.S.
carriers: American, Delta, and
United. If the collapse lasts for six
months, all of 2020 Ebitda (includ-
ing depreciation and amortization)
would be gone.
Yet Vernon and other analysts
aren’t modeling bankruptcy scenar-
ios just yet. Airlines would have to
burn through cash on their balance
sheets, tap revolving cash resources,
leverage assets, and deplete un-
tapped liquidity in the credit markets
before their equity would be im-
paired in an insolvency scenario,
Vernon says. He estimates that the
major U.S. carriers have nearly $100
billion of untapped liquidity—
enough to get them through several
months of bare-bones operations.
“They’ll exhaust short-term mea-
sures and then look at new sources
of leverage and borrowing,” he says,
“but we’re a long way from that.”
Helane Becker, a veteran industry
analyst with Cowen, doesn’t view a
widespread bankruptcy as immi-
nent, yet. But she is sounding more
alarmed. “The airlines are in cash
preservation mode, and we fully ex-
pect to see credit facilities extended
and increased in the next week,” she
wrote in a report on Thursday. “We
previously stated U.S. airline bank-
ruptcies were unlikely and in the
near-term that still remains the case,
BUT if bookings do not improve in
the next three months things could
deteriorate quickly.”
Airlines are talking to their banks
about raising capital, she adds, with
United raising $2 billion this past
week, Delta tapping $1 billion the
week prior, and American receiving
$500 million the week before that.
“It’s probably not going to be enough
in the short term,” Becker writes.
“What is absolutely clear to us is that
there is zero predictability to the fear
that exists and the actions being
taken, making it nearly impossible to
get ahead of.”
Analysts can be forgiven for flying
blind. No disease outbreak in the
modern era caused countries the size
of China or Italy to quarantine vast
populations or triggered a wide-
spread collapse in supply chains,
trade, business, and social activity.
The last three outbreaks—SARS in
2003, avian flu in 2005, and MERS
in 2015—subsided after three
months, followed by a six- to eight-
month recovery in air traffic, accord-
ing to Linenberg. Air travel plunged
40% in the two months after the 9/11
attacksbut gradually recovered.
While the industry suffered during
the financial crisis, carriers managed
to stay aloft and avoid the govern-
ment bailouts that kept banks and
auto makers afloat.
Bob Harrell, an aviation consul-
tant who analyzes fares, calculates
that airlines have seen an 11% to 15%
drop in revenue per mile compared
to a year ago. “On a large base, that’s
a very dramatic cut,” he says. “The
airlines are much healthier than they
were in the last economic downturn
and after 9/11, but this is going to be
a serious test.”
Let’s hope the airlines pass with
flying colors.B