With the U.S. economy reopening following a multi-month shutdown forced by the novel coronavirus Southwest Airlines (NYSE:LUV) and other airline equities are rebounding. LUV stock is really taking off, soaring 16.4% for the week ending June 2.
A week’s worth of trading isn’t much to go on, but a case can be made that the airline rebound is in its early innings because of some of the travel-related names most punished by pandemic, namely cruise lines and casino operators, airlines are the last to bounce back.
While Southwest was part of the rule (there weren’t any exceptions in the airline industry) during the darkest days of Covid-19’s market impact, the carrier did enter 2020 with an industry-leading balance sheet. That’s a crucial factor for investors mulling airline exposure to consider.
With the economy shutdown for essentially all of April and much of May, there travelers – business or leisure – weren’t doing much traveling.
Translation: markets now know second-quarter earnings for airlines are going to be dreadful and that shifts the spotlight to carriers’ abilities to manage costs. Fortunately for Southwest, its cash burn rate is declining and should continue doing so as 2020 moves along, barring a second wave of coronavirus cases.
Painful, but Prudent Steps
Home to tens of thousands of furloughs and layoffs forced by the pandemic, the airline industry is one of the epicenters of the human side of the virus. Southwest, which hadn’t furloughed or laid off workers in its nearly 50-year history, is following rivals in reducing headcount.
On June 1, the Texas-based carrier said it’s offering buyout and temporary leave packages to various employees to bring payroll more in line with the new reality facing the airline business – a reality that includes hundreds of planes on the ground and eliminated routes.
Media reports citing internal documents indicate Southwest CEO Gary Kelly says the moves are necessary to ensure the company’s survival. There’s some silver lining in that if business rebounds more rapidly than anticipated, some of the workers could be called back. However, while the initial reopening ebullience may trigger more near-term bookings than expected, the consensus among analysts is that it’s going to take a couple of years or longer for airlines to look like their 2019 selves again.
As is often the case with cyclical companies operating in trying environments, news of Southwest’s staff reductions was well-received on Wall Street. Markets, as is being confirmed with goings on across the U.S. over the past several days, don’t assess the human side of anything, but there could be some relief for airlines and their workers, according to analysts.
“We have moved well past the point of no return with respect to Covid-19 and its potential to have an enduring, multiyear impact on the commercial aviation industry,” said Credit Suisse airline analysts in a June 2 note.
The Bottom Line for LUV Stock
For Southwest and its rivals, it’s not all cloudy skies. Specific to the low-cost carrier, it previously said April revenue was off 90% to 95% due to weak demand, but channel checks suggests bookings across the industry are climbing off the April lows.
Near-term upside for airline equities could be sourced from evidence confirming that the industry is on a path to normalization in 2021 and on pace to regaining pre-virus capacity levels by 2022. Southwest’s sturdy balance sheet could prove meaningful as investors wait the industry to return to normal.
“We think the best-positioned airlines are firms like Southwest, which came into this crisis with relatively little debt and an efficient cost base,” according to Morningstar. “We still think that Southwest looks cheap for investors with a strong stomach and a willingness to accept a wide dispersion of outcomes.”
Todd Shriber has been an InvestorPlace contributor since 2014. As of this writing, he did not hold a position in any of the aforementioned securities.
