Market Overview

This month's models have been posted. The rest of the newsletter will be published by mid month.

Rough Landing

Ever notice how many business terms come from aviation? “The 30,000-foot view.” “Headwind.” “Golden parachute.”

But there is one troubling term being bandied about now: bailout. You can relax, though. When you hear it related to the airline industry, rest assured it’s in the nautical sense of the word.

Passenger airlines are set to receive $25 billion in grants allocated to passenger airlines in the government’s rescue package, with $4 billion more earmarked for freight carriers. Loans, loan guarantees and tax breaks are also being provided.

Even so, investors are taking leave. Since the world shut down, holding company Berkshire Hathaway has sold off all its shares of United Airlines, American Airlines, Southwest Airlines and Delta Air Lines.

Berkshire Hathaway CEO Warren Buffett leaves a meeting with Delta Air Lines CEO Ed Bastian. Credit: Martin-Baker

If you’ve been flying over the Great Plains with more crewmembers than passengers, then you already know about the airline industry and its current state. Still, maybe it’s time to take a look at the business’s prospects. Will the airlines crash? Or will they pull up in time?

The majors and regionals

When most people think of America’s passenger aircraft fleet, they picture the tail markings of American, Delta, Southwest and United. As of early May, the first two have lost roughly two-thirds of their pre-St. Patrick’s Day market cap, the last has lost around three-quarters, according to Yahoo Finance. Southwest, with its low-cost model, held up a little better, shedding 42% of its value.

But the U.S. Department of Transportation has a more expansive view of what constitutes a “major carrier.” You’d also have to include Alaska Airlines, which has dropped from $65 to $28 per share in a matter of weeks, and Hawaiian Airlines, the tenth-largest U.S. airline, which is struggling along with its peers.

The other mainline passenger carriers are characterized as budget airlines and include JetBlue and Spirit Airlines. JetBlue has seen less decline than its peers but, even so, lost more than half its equity value. Spirit, though, appears to be among the worst performer in the industry, dropping more than 70% year-to-date as of this writing, also according to Yahoo Finance.

Freight

The story is not quite as dire for the flying trucks that deliver parcels and high-volume cargo across the U.S. As people stay home, the supply chain needed to keep them there becomes crucial.

Atlas Air is up more than 28% year-to-date, and you can see the irony if you squint a little. Of all the things to name a delivery company! We’re having a moment now when it almost doesn’t matter if Atlas shrugs, as long as Hermes doesn’t.

The two most recognizable names in this category, though, are doing better than the passenger airlines, but that is faint praise indeed. FedEx Express is the backbone of the massive FedEx package delivery operation, but the parent company is down almost 25% year-to-date. Similarly, UPS Airlines is the captive air freight operator for its parent, United Parcel Service. UPS – they hate it when you pronounce that “Oops” – is down about 20%.

It should be noted that these two stocks were already tanking a month before the world got canceled, that is, right after they announced fourth-quarter 2019 earnings. FedEx has had a long history of earnings disappointments to start with, and UPS has had some turnover in its top management. Then, during the present crisis, they have both been eclipsed by Amazon, which has an impressive logistical operation of its own.

Flight plan

So, there’s the snapshot, but it tells us little about what’s in store. To help in ascertaining that, we need to ask ourselves three questions:

1. How bad is it going to get for the airlines?
2. How long until the industry fully recovers?
3. And, assuming the industry does fully recover, will the airline you fly for still be around?

Let’s address Question 3 first. It’s not impossible that an airline will fail, but that’s unlikely. United filed for bankruptcy after 9/11 and, following the subsequent merger with Continental, briefly became the largest airline in the world. The story is messier with USAir, which also went bankrupt then combined operations with America West Airlines. The successor company became US Airways, an independent, viable carrier until it merged with American, today's market leader, in 2015. The largest airline to fail outright as a result of 9/11 was regional player Aloha Airlines.

The CARES Act, which we discussed last month, sets aside $61 billion for direct aid to the aviation sector, split roughly in half between loans or loan guarantees and payroll protection grants. And that figure, roughly six times the federal aid available to the airline industry in the wake of 9/11, doesn’t include a tax holiday, which is also baked in. So, while we won’t swear to it that all readers of this newsletter will keep their jobs – United, for example, already projects the loss of more than 4,000 pilot positions – it won’t be the U.S. Treasury’s fault if they don’t.

As of this writing, according to Lexology:

• Alaska will receive $1.0 billion in payroll assistance,
• American will receive $5.8 billion,
• Delta will receive $5.4 billion,
• Hawaiian will receive $0.6 billion,
• JetBlue will receive $0.9 billion,
• Southwest will receive $3.2 billion, and
• United will receive $5.0 billion.

These gifts are not without strings. In all cases, the federal government is granted equity stakes, much as it was in 2008 when it rescued the banking and automotive sectors. It bears mentioning that Washington quickly sold off those ownership positions rather than nationalize those industries, so perhaps we can expect the same treatment of airlines today. To date, Allegiant, Frontier, SkyWest and Spirit have not confirmed details of any possible agreements. As for the freight shippers, FedEx hasn’t announced any information about grants or loans, but did acknowledge that it would save $250 million from the CARES Act’s tax break. UPS, meanwhile, has suspended share buybacks, a condition imposed on any support related to payroll protection.

Let’s continue in reverse chronological order and answer Question 2. It’s really anyone’s guess how quickly the airline industry will recover, but best guess is that it will basically track the economy. We know this recession will be deep, but we don’t have a firm grip on how long it will go on. The stock market has rebounded quickly so far, but the market is not the economy. Even so, stock markets are mostly forward-looking and are considered a leading indicator of where the economy is headed. This low point in the cycle might turn out to be more-or-less V-shaped, but we really don’t know. A lot depends on the speed that Covid-19 treatments and coronavirus vaccines can be developed and distributed, and how quickly accurate diagnostic and antibody tests can be brought to bear.

Another way of wording Question 1 is, “Can it get any worse for the airlines?” Possibly, but how? The good news is that oil is cheap. We literally have more of it floating around in tankers than we have places to park it until it can be used. While the price of a barrel is now back above $0, it’s near historical lows and it could take years to burn through the excess supply sloshing around out there. So when people feel safe traveling again, fuel costs will – for a change – be the least of the industry’s concerns. Still, there are bound to be some structural changes for the industry, mostly around how connecting flights are routed. Transportation consultant Kunal Shah has an excellent piece on the subject in his series at Forbes.com.

We hope we didn’t upset you too much, but we’d have been remiss not to bring up this subject. The airline industry isn’t just your employer; it’s also an industry that you may have an outsized proportion of your investment portfolio exposed to. You likely took a big paper loss in March and April and are wondering if you should hold your shares or dump them.

Whichever you decide, be sure that your choice isn’t based on your own personal biases. We covered such topics as loss aversion and the bandwagon effect in this space, and that article is worth a re-read. The best way to ensure that you’re making rational, dispassionate decisions is to talk to a financial professional.