United Airlines (NASDAQ:UAL) reported July 21 during the release of its second-quarter results that it will only burn $25 million in cash per day during the third quarter, 38% less than its daily burn rate in Q2 2020. Since this announcement, UAL stock has gained 12%.
Woohoo! The worst is behind it.
My InvestorPlace colleague, Brad Moon, recently suggested that despite the uncertainty facing the airlines, United included, it appears UAL’s stock has bottomed and is slowly pulling itself out of its nosedive.
While I don’t think there’s any doubt institutional investors are starting to nibble around the edges when it comes to United, I’m hard-pressed to explain why any investor would want to own a stock that lost $1.6 billion in its latest quarter and likely will lose a big chunk more when it reports Q3 2020 in October.
When there are so many options available that haven’t lost billions during the novel coronavirus, I’m not sure why you wouldn’t allocate your capital elsewhere.
To buy UAL stock at this point, merely because it will drop its daily burn rate by 38%, is pure insanity. Here’s why I feel this way.
More Firms to Go Bankrupt in 2020
On August 4, Virgin Atlantic, the U.K. airline founded by Richard Branson, the same guy behind Virgin Galactic (NYSE:SPCE), filed for Chapter 15 bankruptcy. While no major U.S. airline has filed for bankruptcy, Delta Air Lines (NYSE:DAL) owns 49% of Virgin Atlantic, so anything it’s owed by the airline has been deferred until its situation gets sorted.
The reality is we’re going to see more bankruptcies between mid-August and the end of the year. Through mid-July, a total of 30 American companies with liabilities exceeding $1 billion have filed for bankruptcy. That number is expected to hit 60 by the end of the year. Fitch Ratings believes corporate defaults in 2020 could exceed the level seen in 2009.
“There was a huge build-up in corporate debt by the end of 2019, and I thought the market would gain some much needed deleveraging with the Covid-19 crisis,” said New York University Professor Edward Altman, the man behind the Altman Z-Score.
“Now, seems like companies again are exploiting what seems to be a crazy rebound.”
If you’re unfamiliar with the Altman Z-Score, it’s a financial metric that indicates the likelihood of a company going bankrupt within the next 24 months.
In case you’re wondering, United’s Altman Z-Score is currently 0.66. Anything below 1.81 indicates the likelihood of bankruptcy in the next 24 months is high. By comparison, Southwest Airlines (NYSE:LUV) has a score of 1.87, which means it’s just outside the distressed zone, but remains in financial distress. American Airlines (NASDAQ:AAL) has the lowest score at 0.28.
Thinking about United from the daily rate, it lost $1.6 billion from a daily burn rate of $40 million. So, based on a 90-day quarter, $3.6 billion in cash is going out the door, 44% of which is converted into losses. If we reduce this daily burn rate to $25 million, we’re talking about $2.25 billion in negative cash flow or slightly less than a billion dollars in losses based on the same 44% conversion rate.
I don’t know about you, but I’d rather put my hard-earned capital into something generating $1 billion in profits and excess cash flow of $2.25 billion.
I couldn’t tell you if United or anyone else of the big four will enter Chapter 11 during 2020. What I do know is that the risk to reward remains heavily weighted against the investor.
The Bottom Line on UAL Stock
My most recent article about an airline stock was July 24. In it, I argued that Delta chief executive officer Ed Bastian’s bold move to keep the middle seat empty through the end of September, and possibly into 2021, would win the airline some new customers.
At the same time, I thought United’s disinterest in passenger safety would ultimately cost it passengers. Furthermore, I stated that under no circumstances should investors buy UAL stock.
Almost three weeks later, I continue to put United in the third spot out of the big four, ahead of only American, but behind Delta and Southwest.
If you’re going to speculate on the airline stocks, and you refuse to do it through an exchange-traded fund like U.S. Global Jets ETF (NYSEARCA:JETS), buy DAL or LUV. Do not buy UAL even if it looks like it’s bottomed.
Looks can be deceiving.
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.