In the beginning of May, when Warren Buffet revealed that he had sold his entire position in American Airlines (in which he had a 10% stake), Delta Airlines (9%), Southwestern Airlines (10%), and United Airlines (8%), he declared “the world has changed for airlines”. Of that there can be no doubt. His sale followed dramatic falls in the share prices of companies throughout the airline-industrial complex in February and March, as the devastating global nature of coronavirus became clear. With the implementation of travel bans and widespread avoidance of flying for fear of infection, passenger numbers tumbled (96% in Q-2 at Heathrow for example) leaving airlines in dire straits.
However, just as Buffet was offloading his positions in these companies, there was a large flurry of purchases from industry insiders, including $640,000 purchases of Delta shares in late April and $1.1 million of American Airlines. Despite 58% and 62% falls in these companies, respectively, and similarly dramatic falls in other airlines, this confident sentiment suggests that the longer-term outlook for airlines may not be as gloomy as recent news would have you believe.
For one, initial fears of bankruptcy, encapsulated back in May 12 by Boeing CEO David Calhoun who predicted that a major US carrier would “most likely” go out of business, seem to be residing. Governments have taken heed of the fact that 1/15 jobs are linked to the airline industry (when airport hospitality is included) and have provided substantial relief in order to safeguard these jobs. The US government approved a $50 billion bailout package for airlines, half in payroll grants and half in loans, and by late April €12.8 billion had already been applied for in Europe. In addition, airlines have not been reluctant to raise funds from private investors with British Airways owner IAG announcing a €2.75 billion rights issue on Friday. With cash burn being reduced dramatically- Delta’s reduction to around $25 million a day from $100 million in late March, coming after an impressive 50% reduction in operating expenses leaves it with 19 months of liquidity- and funds readily available, it looks likely that major carriers, especially those with lower debt levels such as Southwestern, will be able to weather the storm.
Whilst survival is most likely ensured, it will not come without cost. Record losses, with IAG for example losing more in Q-2 than they had ever done in a whole year, will of course cause damage to the companies’ balance sheets. Increased debt will mean higher interest repayments in future years and share dilutions will have permanent effects on EPS.
However, even with these factors exacerbating future earnings, the dramatic falls in price do not seem justifiable by the losses incurred so far. To take Ryanair as an example, the difference between the profit of $29 million in the first half of 2019 and the loss of $860 million in the same period this year cannot even account for a fifth of the $4.8 billion wiped off its market capitalisation since the beginning of the year. Large hits to net income will, of course, continue into the second half of the year, when Ryanair makes the lion’s share of its profit, but with 40% of flights already resumed, assuming the prevailing downward fall in European coronavirus cases continues, the downward pressure on revenues will begin to significantly ease off.
That is of course a large assumption. The threat of a second wave was described by Ryanair bosses as “our biggest fear” and its impact was recently shown by the quarantine rules imposed for travellers returning to the UK from Spain after their recent uptick in cases. In the U.S, the story is of course different with the first wave showing no signs of subsiding, even if cases appear to have flatlined at their peak of around 60,000 cases per day in the past three weeks. However, compared to Ryanair at least, most major U.S airlines are trading at a significantly greater discount in accordance with the longer period of near-zero revenues and cash burn.
Much will rely, therefore, on the progress of vaccines. Thankfully, there is a case here for cautious optimism. Astrazeneca, which plans to produce 2 billion doses of the vaccine it produced in partnership with Oxford, has been making startling progress. CEO Pascal Soirot recently announced that in early trials “we have good data so far”. Phase 3 trials for that vaccine are already beginning, and with plans to begin manufacturing in concurrence with clinical trials, they hope to roll out their vaccine as early as September. This is to say nothing of the numerous other emerging vaccines (the UK has orders for three others), which will put an expiry date on coronavirus if successful.
However, even if coronavirus were to end today the speed of recovery of the general economy would be of crucial importance to a full return to normal passenger numbers. After record GDP contractions in Q-2, unemployment is predicted to more than double in the UK after the furlough programme ends in October, even if according to the Resolution Foundation almost half of those furloughed at the late April peak are now back to work. It is far from clear which course the economy will take. Even with low oil prices supporting a recovery (futures being in contango point to an upcoming supply glut), the post-coronavirus world will still see lost profits compared to pre-coronavirus projections. The question, therefore, is just how severe those will be. Whilst Goldman Sachs CEO David Solomon has recently predicted a V-shaped recovery heading into 2021, a British Airways spokesman has also announced that “we do not expect our company to return to 2019 levels of business until at least 2023”.
It is clear, therefore, that there are a number of major uncertainties clouding one’s ability to firmly declare the dramatic falls in airline industry share prices excessive. The most significant, of course being how successful efforts to curb coronavirus are. Taking a longer view, however, it must be remembered that the airline industry enjoyed a tenth year of profits in a row in 2019 and were expecting growth in 2020. With these positive trends, alongside very strong share price increases of between 80-120% in the six months after the last three major crises to hit them (9/11, 2003 SARS outbreak, and 2008 Financial Crisis), there is reason to be bullish about airline prospects, especially given the extent to which they are currently trading at a discount.
The Sweeney Club 