Back of the envelope, there’s an intriguing case for United Airlines (NASDAQ:UAL) at the moment. Back in 2019, before the novel coronavirus pandemic arrived, United earned more than $12 per share (on an adjusted basis). Right now, UAL stock trades at $54.
If United can get back to even half of those 2019 profits, and again receive the same low double-digit multiple that airline stocks generally received pre-pandemic, there’s obvious upside.
That said, something like 11 times $6 in earnings per share (EPS) suggests healthy upside from current levels. And given that United, after January’s fourth-quarter report, guided for 2023 EBITDA (earnings before interest, taxes, depreciation and amortization) margins to exceed those of 2019, it may not take that long for EPS to get back to $6 or better. Indeed, Wall Street consensus projects about $7 for 2023 EPS, albeit with a huge range ($3 to $13).
Obviously, investors can and will create more sophisticated, more individualized and more detailed models, but the core point holds. Specific earnings targets aside, there’s likely a significant amount of pent-up demand that could strengthen near-term results. That demand may drive not only ticket sales, but pricing as consumers splurge on long-awaited vacations.
All told, there’s an admittedly intriguing case for the sector — but there are risks as well. More importantly, for UAL stock in particular, one clear qualitative concern stands out. It’s a risk highlighted by a passage from last month’s Q4 conference call.
The passage seems innocent enough at first read. But understanding what it truly means shows the core risk to UAL stock and the entire sector — a risk that keeps raising its ugly head across the industry.
Prior to the Pandemic for UAL Stock
“This crisis has afforded us a number of valuable lessons about the balance sheet and capital allocation. Before COVID, we modeled our worst-case scenarios based on the financial impact of 9/11, followed by a recession. It turns out we weren’t even close. Going forward, we will focus on being ready for sustained destruction of global air travel demand like we are seeing today.”
That quote comes from United chief financial officer Gerald Laderman on United’s fourth-quarter conference call back in January. It’s a truly stunning admission.
United’s own CFO, who has been with the company for more than three decades, and who received $3.6 million in total compensation in 2019 (2020 figures haven’t been released yet), never bothered to model what a global pandemic would do to United’s business.
That’s despite the fact that a global outbreak of disease was twice mentioned in the “Risk Factors” section of United’s Form 10-K filed in February 2019, long before the novel coronavirus pandemic. And it’s despite the fact that United itself had to cut flights when SARS hit back in 2003.
That said, United and Laderman simply ignored the risk. It’s fair to argue that United can’t run its business based on the risk of a pandemic, but even in contemplating “worst-case scenarios,” Laderman never bothered to quantify that risk.
Thus, any investor even considering UAL stock should remember that the same executive is in charge of quantifying risks going forward — in an industry that historically has proven to be among the riskiest on Earth.
Does It Matter?
Let’s be fair: Stock prices are based on what will happen in the future, not what happened in the past. Laderman claims that United has learned a “number of valuable lessons” from the pandemic. Going forward, United will make sure it is better prepared for a pandemic or anything else that causes “sustained destruction of global air travel,” as Laderman put it.
However, the effects of the modeling error aren’t just in the past. They affect the future as well. Between 2016 and 2019, United repurchased some $6 billion worth of stock, according to filings with the Securities and Exchange Commission. That capital could have gone to paying down debt. It could have been kept on the balance sheet to cushion the impact of a recession (which, even before the pandemic, seemed ‘due’ at some point).
Neither happened. United did nothing to de-risk its business. So United instead had to spend 2020 raising whatever financing it could. Total debt increased $12 billion over the course of the year (to be fair, the cash and short-term investments balance increased nearly $7 billion as well). At Feb. 18, 2020, 248 million million shares of UAL stock were outstanding. At Feb. 24 of this year, 318.5 million.
Even if you assume United’s operating profit can return to 2019 levels, that profit is spread across nearly 30% more shares. There’s another $800 million or so in added interest expense, based on the price of last year’s major bond issue. After-tax, that’s nearly $2 per share.
Suddenly, the path for United simply getting back to 2019’s $12 per share in EPS looks much, much tougher.
Lessons and UAL Stock
Over the years, airlines have promised that, this time, they’ve learned their lesson. And investors have believed them.
At a certain point, that trust simply gets broken. The Covid-19 pandemic seems like that point — and it wasn’t just United that whiffed.
In fact, a Bloomberg analysis showed that the industry as a whole over a decade spent a staggering 96% of its free cash flow on stock buybacks.
Maybe this time is different. Maybe the airlines, finally, are going to run their business in a more conservative way. That seems like a risky bet to take, however. The industry has struggled not only over the past year-plus but the past few decades. United itself filed for bankruptcy back in 2002; Southwest Airlines (NYSE:LUV) is the only major carrier that has never done so.
And if the non-Southwest airlines want to prove that this time is different, some accountability would be useful. There’s been none. Laderman still has his job (and failing to model a massive risk should be a fireable offense). Parker still has his.
In short, U.S. airlines, United included, don’t seem all that upset about the massive destruction of investor capital over the last 14 months. That makes it hard to believe they’re truly doing everything in the power to prevent more capital from being lost once again.
On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.
After spending time at a retail brokerage, Vince Martin has covered the financial industry for close to a decade for InvestorPlace.com and other outlets.