In what’s got to be one of the least surprising news stories for the first day of May, United Airlines’ (NASDAQ:UAL) $1.7 billion loss in the first quarter caused UAL stock to fall by more than 10%.
Investors could see from a mile away that the airlines were going to lay an egg when it came to first-quarter earnings. No one should be surprised about United’s quarterly report.
What I want to know is whether this decline was a case of the old Wall Street idiom, “Buy on the rumor, sell on the news” or is there more to the story? Are we facing the next round of airline bankruptcies that seem to happen every few years? More importantly, does the drop in UAL stock call for investors to buy on the dip, or can we expect further losses in the weeks ahead?
I’ll consider both sides of the argument.
UAL Stock Will Continue to Fall
One of the biggest takeaways from United’s first-quarter conference call was incoming CEO Scott Kirby’s realistic assessment of near-term travel conditions for U.S. airlines.
“When we say plan for the worst and hope for the best, however, we really mean it and we’re therefore planning for the environment to possibly continue at essentially zero net passenger revenue for the rest of the year and into 2021. We aren’t projecting that and certainly hope it’s better than that, but we are planning for the possibility,” Kirby stated in the May 1 conference call.
Even if the company can maintain a daily cash burn of $40-$45 million through the final nine months of the year, that’s $11.6 billion out the door (365 days divided by 12 months multiplied by $42.5 million at the midpoint) with nothing to show for it in return.
Kirby reasoned that it would have approximately $9.6 billion in liquidity at the end of June, taking into account receiving the rest of the $2.5 billion it’s getting from phase one of its loans and grants under the CARES Act.
It essentially is going to burn through the first phase of its loans and grants in the next two months. Clearly, it will need a lot more in government loans if it’s going to make it into 2021 in decent shape.
He goes on to suggest it will finish the third quarter with $6 billion in liquidity and should have more than $10 billion heading into the final quarter of the year. This means that it will burn approximately $39 million a day in the third quarter.
Let’s assume United can get the daily burn rate down to $35 million, it will finish the year with approximately $7.3 billion in liquidity ($10.5 billion less 92 days times $35 million).
That might sound good but how enthusiastic are investors going to be about buying into a company that’s burning that much each day with the potential it could actually carry on into 2021?
The same problem exists for the cruise lines and I don’t see too many financial experts saying the cruise line stocks are a lock. Aggressive investors might be looking to profit from the uncertainty, but for the rest of us, it’s too risky a bet.
I could see UAL stock in the low $20s or even high teens by the time it reports its second-quarter results in July.
United’s Stock Should Steady Itself
Analysts were expecting much worse from United.
While the GAAP loss of $1.7 billion was bad, on an adjusted basis it was just $639 million. I say “just” because analysts thought its loss would be as high as $1.1 billion on an adjusted basis. Delivering a loss that was 40% less than expected suggests the airline got a hold of its expense structure very early in the global outbreak and did a good job pruning costs.
Therefore, it’s logical to think it won’t have a problem carrying on with the belt-tightening for the remainder of the year. Pardon the pun, but it’s got its expense structure on autopilot.
Now, imagine if it manages to get some warm bodies on its planes in the second quarter and beyond. Well, no longer is it facing life under a zero net revenue environment. If that happens, you can be sure UAL stock will stabilize, if not rocket higher.
Remember, investors are forward-looking by six months. If they see greater confidence from air travelers, they’ll assume 2021 won’t be so bad after all.
The really successful investors are looking past the next 3-6 months, trying to envision what the travel industry will look like farther in the future.
Personally, like the cruise industry, I can’t imagine people permanently staying home. It’s unnatural. Perhaps, it’s even Un-American.
The $20-million question is whether 2021 returns to historical passenger volumes or do people opt for the open road.
People didn’t want to fly after 9/11 but things eventually got back to normal. I expect the same to happen now.
The Bottom Line
The last time I wrote about United was on March 20. At the time, I suggested “If you must own UAL stock, buy Berkshire Hathaway (NYSE:BRK.A, NYSE:BRK.B) instead. Otherwise, stay far away.”
On May 2, during Berkshire’s virtual annual meeting, CEO Warren Buffett confirmed that the company sold its entire UAL position along with those of Delta Air Lines (NYSE:DAL), Southwest Airlines (NYSE:LUV) and American Airlines (NASDAQ:AAL).
I said that before the bailouts and before the deaths started piling up. Six weeks later, United’s situation is actually much worse. That said, I’ve found in life that when you fear something happening, the ultimate result is never as bad as you think it’s going to be.
If you’re an extreme risk-taker, I would have said UAL’s a buy in the low $20s. But that was before Buffett sold out. Now, I wouldn’t touch it until the mid-teens. For everyone else, I’d stay away. As for Berkshire, it’s always a good buy, with or without the airlines.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
