Airlines stocks are under the hammer as the U.S. grapples with a possible second wave of the novel coronavirus. United Airlines (NASDAQ:UAL) is a casualty of this bearish outlook. After falling to historic losses in mid-March, United Airlines stock erased its losses over the last three months until reports emerged of a spike in cases once reopenings went into effect.
That’s a shame since I believe UAL still offers a lot of upside under $40 a pop. The legacy carrier continues to boost liquidity as passenger numbers rise with every passing week.
Daily cash burn will fall to approximately $10 million in the third quarter, leaving it with plenty of capital in case of a prolonged slowdown.
That’s not to say I am not aware of the acute problems the airline finds itself in. Debt is increasing at a rapid rate, and the company is expected to scale down operations, inhibiting future growth. And while air travel demand is rising, it will take time for it to get to pre-pandemic levels.
However, there are still enough reasons for me to back UAL stock at this time.
A Closer Look at United Airlines Stock
Liquidity is a burning issue for every airline at the moment. Experts agree that it will take a long time before we see airline travel return to its levels before the crisis. That’s why it’s a no brainer that operational cash flow will be stressed during this time.
As I wrote in my previous article, UAL has done well to shore up its balance sheet to make sure it survives the crisis. Since that time, the company got another $5 billion secured by the airline’s loyalty program, bringing total liquidity to approximately $20 billion.
Considering cash burn will drop to $30 million in Q3, UAL already has enough capital to ride out the year. The only catch here is the increased interest expenses that will weigh down the bottom line for years to come. That’s why I think it’s in the company’s best interest to not take out any further loans.
The global economy is slowly getting back on its feet, shaking off the effects of Covid-19. Passenger numbers are following suit but are still way off year-ago figures. Transportation Security Administration data reported that checkpoint throughput travelers totaled 625,235 on June 29, a 614.277% increase over the 87,534 figure reported on April 14. Still, there is still a long way to go — passengers totaled 2,455,536 on June 29, 2019.
United Airlines is playing to add 25,000 flights in August, citing the increase in demand. Although the August 2020 schedule represented just 40% of flights in 2019, the uptick in air travel demand will continue in the forthcoming months.
Scaling Down Strengthens United Airlines Stock
In April, CEO Oscar Munoz and President J. Scott Kirby issued a joint statement in which they said that the company is looking to become smaller “starting as early as October 1.”
As the company scales down operations it stands to save a lot of cash, especially among routes that are not offering a lot of traffic. The bad news is that a sizable chunk of furloughed workers will lose their jobs by the end of September.
More importantly, the reduction in routes and capacity will mean that future growth for the legacy carrier will remain stressed. Hence it makes sense for the company to adopt an effective cost-saving strategy and streamline operations.
UAL Stock Valuation
As of this writing, UAL stock trades at a price-to-earnings ratio of 8.67x, a 53.86% discount to the sector median of 18.80x. Using a 12% discount rate, I have come up with a fair value of $38.91 per share.
Rates for growth and terminal periods are 5% and 3.22% (the average inflation rate for the last 20 years). Horizons for the growth and terminal periods were 10 years each. That gives us a margin of safety of 11.46%, not too bad considering the current state of affairs.
Final Word on UAL Stock
Although legroom is diminishing, UAL still offers a lot of value under $40. The company has taken the necessary steps to shore up its balance sheet to survive a prolonged slowdown. There was a genuine need to scale down until demand returns to pre-pandemic levels and streamlining operations is a prudent strategy at this time.
It goes without saying that the airline industry is facing an unprecedented crisis and carriers have to adjust accordingly. It seems like ages have passed since the company was spending 80% of its free cash flow on buybacks. It will take a while for those good times to return. But the company has done all that it can to weather this storm and the markets will reward this initiative.
UAL stock remains a buy for me at this stage.
Faizan Farooque is a contributing author for InvestorPlace.com and numerous other financial sites. He has several years of experience in analyzing the stock market and was a former data journalist at S&P Global Market Intelligence. His passion is to help the average investor make more informed decisions regarding their portfolio. He does not directly own the securities mentioned above.