Why airline stocks, even with omicron, could finally get financial support

Delta Airlines Boeing 737 departs from Los Angeles Airport, California.

FG | Bauer Griffin | GC images

The recent history of airline investment has been volatile, with the events from 9/11 to the financial crisis and the Covid-19 pandemic creating several lows for several sectors.

But is it possible that everything is all right with the airlines? Longtime airline stock skeptic Warren Buffett has made big bets on US airlines following the recent wave of consolidation, but when Covid hit, he backed out.

Now, shares of leading carriers such as Delta Air Lines are recovering from a brief near-panic attack caused by the emergence of a new Covid-19 strain, a variant of the omicron that was first discovered in South Africa and is now tagged in 50 countries and 19 US states. After the correction of the NYSE Arca Airline Index, which saw a 25% fall for Delta, the most valuable US carrier, airline stocks rallied, although they are still at levels lower than they were a month ago.

Analysts point to several factors that make this flurry of Covid fears unlike others, fueled, first, by the initial wave of the pandemic in March last year, and not too long ago when the delta options market got scared in the summer. First, and most importantly, this time around, passengers are not giving up on air travel, even though there are current restrictions on international travel and the potential impact of the omicron remains to be judged by the body of scientific evidence that is still being collected. Recent data, although not peer-reviewed, has shown that omicron can shy away from vaccine protection more than delta, even if it does not cause serious illness, and Pfizer CEO Albert Burla told CNBC on Wednesday morning that the booster vaccination can help.

Capital markets, meanwhile, showed they would support carriers by lending them money or even buying more shares, and Delta and other carriers worked to cut costs and received federal aid designed to limit layoffs and keep airlines afloat.

“There will certainly be a omicron impact, but it won’t be as strong and lasting as last week’s sell-off suggests,” said CFRA Research analyst Colin Scarola, who says he told customers to buy flop.

The first number that informs an investor about the state of affairs in an airline is the passenger load factor – the percentage of seats occupied on each plane, reported by the US Department of Transportation and the International Air Transport Association. In addition, the Transportation Safety Board monitors airport traffic and is published more frequently than sales data.

In the lead-up to the omicron headers, the traffic kept pretty good. TSA says recent airport traffic was around 85% of its pre-Covid peak in late 2019 – not as good as the nearly 90% posted over Thanksgiving weekend, but better than some investors feared. Last week, Bank of America Merrill Lynch reported that traffic fell less than investors had feared.

This is better than the airlines during the delta option, according to CFRA Research analyst Colin Scarol. Airlines lost almost six percentage points to their occupancy rate in August, falling to 78.7% seats from 84.3% in July, according to government data. (Peak pre-Covid rate was 88.8% with more flights.)

“People are used to the idea that you may not be protected from the virus, but you will not get seriously ill,” said Scarola. “It makes the task easier. We have overcome this hump. “

This would bring the behavior of airline stocks in line with what has been learned about the economy and the market since the start of the pandemic: the economy learns to better cope with each successive wave, and the stock market is recovering faster because of fear.

With careful management, airlines can profit from the fact that load ratios remain relatively stable, Scarol said.

A Delta spokesman said the company would not comment on its plans or forecasts, but pointed to the company’s third quarter as a testament to how it will handle any downturn in the omicron market. The Delta Option hurt all airlines ‘traffic in the third quarter, bringing Delta Air Lines’ utilization rate to 80%, eight points below pre-Covid levels.

However, the company generated $ 216 million in pre-tax profit on sales of $ 9.15 billion, not including over $ 1 billion in temporary government assistance. During a conference call on earnings, executives brought up a long list of drivers. More diversified revenue streams as increased focus on transporting goods on less congested international routes boosted sales; the company’s credit card deal with American Express brought in more royalties; and has kept fuel costs in check as the company resorted to buying more used aircraft in its long-term fleet renewal to improve fuel efficiency, even paying cash for more aircraft to contain financial costs.

“Simplification and revitalization [our] fleet[es] a constant change in our cost structure, with profits estimated at about $ 400 million in 2021 and about $ 650 million in 2022, “Delta Chief Financial Officer Daniel Yankey said during a conference call.” That’s up from 2019. These savings will continue to grow. in years to come, as we move into the delivery of the next generation of aircraft, we will restore the volume of flights and further simplify the fleet. “

Overall, Delta reported that its cost per mile was 7% lower than in the third quarter of 2019, the last pre-pandemic summer season. Its capital expenditures fell 12%. His cash and short-term investments totaled $ 13.2 billion, up from $ 1.9 billion two years earlier.

Profit forecast for American Airlines, Southwest

The management of major airlines is changing. On Tuesday, American Airlines announced that longtime CEO Doug Parker is stepping down to be replaced by Robert Isom. Southwest Airlines CEO Gary Kelly will step down in February.

In the recent history of the market, airlines were not the best option. Parker, who initially became America West’s CEO shortly before 9/11, oversaw a series of airlines and mergers during the crisis, financial crisis and Covid. “I don’t think we’ll ever lose money again,” Parker said on the company’s Investor Day in September 2017. After a peak in January 2018, American stock fell about 70%.

Parker told CNBC on Tuesday that the airline “has a solid financial footing” and “demand is back.”

Isom declined to discuss a profitability path, and American Airlines officials said that every time travel restrictions appear, it weakens travel, but there is “pent-up demand” in the corporate market, judging by conversations with CEOs and other corporate buyers with whom the company is in contact and is betting that the corporate market can recover as early as next year.

Southwest said Wednesday it expects fourth-quarter profitability as demand and tariffs rise. Its 2022 forecast suggests profitability and capacity could range from 3% decline from 2019 to 2% growth.

Balancing capital accumulation with cash accumulation was made possible by capital markets that remained willing to lend to airlines throughout the pandemic, according to analyst Peter McNally of consulting firm Third Bridge Group. Executives at American Airlines, which took on more debt during the Covid, told CNBC that the company plans to reduce its debt burden as demand rises. And that demand is fueled by growing evidence that flying, especially with camouflaged, mostly vaccinated clients, is not a high-risk activity for Covid transmission, McNally said.

“There is a long way to go until next summer,” McNally added.

Lower costs and a more efficient fleet have pushed airlines to recover sharply as passenger traffic resumes, Scarol said. The omicron panic may delay this process, but he still believes that pressures and other traffic measures will return to pre-pandemic levels by early 2023, after improving over the next year. Particularly important, he said, is the return of high-yielding business and international travelers, who return more slowly than domestic tourist trips.

“By the end of 2022, revenue will be in the 10% range from pre-Covid levels – not entirely, but close,” Scarola said. “I really think we will be back in 2023.”

– CNBC’s Leslie Josephs contributed to this report.

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