You have to love the enthusiasm of investors. After watching LUV stock plunge more than 50% for the year in mid-May, investors seem committed to buying Southwest Airlines (NYSE:LUV). At one point, the stock was up over 20% in the month of June before falling back.
By now the narrative for or against any airline is simple enough. Demand will either come back soon, or it won’t. I know that’s brilliant analysis, but it sums up the situation. This article by Josh Enomoto makes a similar point.
However, if a recent study is accurate, airline traffic will not only have to get better, but get significantly better, for Southwest to justify its 12-month price target of $49.32. However the actions the company is taking don’t seem to warrant such a rosy outlook.
The Strong Get Stronger
One of the factors working in Southwest’s favor prior to the pandemic was the company’s strong balance sheet. That has only been strengthened during the pandemic. In fact, through a combination of measures that included assuming new debt, taking out short-term loans and issuing an equity offering, the airline increased the cash on its balance sheet to $13 billion.
With $13 billion of cash in hand, Southwest expects to have enough money to cover 20 months of cash burn (and here’s the key phrase) even if there is no improvement in business trends.
In my estimation, that’s not good news. It suggests that Southwest is taking this approach because it expects conditions to remain roughly the same. And, unfortunately, that looks to be an accurate assessment.
And here’s something else to consider. Although Southwest still sports the highest credit rating among its peers, it still saw its credit rating get cut to BBB from BBB+
Statistics Speak Very Clearly
Airlines for America recently updated its report on the impact that the novel coronavirus is having on the airlines. The update, published on June 22, took into account data collected through June 14.
I’m habitually skeptical of statistics, but when you look at these numbers in the aggregate it’s hard to ignore the clear message. It’s going to be a long year for airline travel.
Domestic air travel is still down 80%. And international air travel, which is down 96%, remains virtually nonexistent.
U.S. flights are down 69% system wide. There are, on average, 58 passengers per departure. Over 40% of the U.S. airline fleets remain idle.
But that doesn’t tell the whole story. Airlines will face an elevated break-even load factor for the rest of the year. In fact, in the second quarter, even a load factor of 100% would not have been enough for airlines to balance their books.
But let’s cut to the chase. Here’s the number that really makes you think. Demand for future U.S. air travel is down 74% and net booked revenue is down 87%. Both of those numbers are on an uptrend, but from levels that were unprecedented. They really had nowhere to go but up.
It’s Not Time to Buy LUV Stock
I was an advocate for Southwest Airlines in March. And as recently as last month, I suggested that LUV stock may have found a bottom. That may be the case. Then again, there wasn’t a lot of guts in calling a bottom on a stock that had already fallen over 50% for the year.
But Southwest is telling a different story. Shoring up its balance sheet makes complete sense. And it ensures that Southwest will not be a surprise airline to file for bankruptcy.
However, it also suggests the company is less bullish on how fast that recovery will get here. The company’s CEO Gary Kelly went on the record in May as saying the industry was not going to get back to pre-Covid-19 levels for at least a year.
In the last 20 years, the airline industry has been through two major shocks. First was 9/11 and second was the global financial crisis. In both cases, it took years (plural) for demand to recover.
One could make the assertion that Covid-19 is a more vexing problem for the industry. On the one hand it’s caused demand to collapse in an unprecedented fashion. On the other hand, a vaccine could cause demand to snap back very quickly.
But if you’d like to bet on when a vaccine will be available, I’m sure you can find a casino that’s open to take your bet. In the meantime, it’s probably a good idea to stay away from LUV stock.
Chris Markoch is a freelance financial copywriter who has been covering the market for over five years. He has been writing for InvestorPlace since 2019. As of this writing, he did not hold a position in any of the aforementioned securities.
