- American Airlines (AAL): Credit metrics have worsened since the pandemic and the airline faces significant debt servicing costs. Renewed slowdown would imply an extended period of cash burn.
- United Airlines (UAL): Another airline company that has a stretched balance sheet. Focus on recovery will be on deleveraging. Equity dilution remains a possibility.
- Delta Air Lines (DAL): A healthier balance sheet and improvement in core metrics. However, the stock looks expensive in a recession scenario.
Since the onset of the covid-19 pandemic in 2020, airline companies have continued to experience turbulence. This has reflected in the under-performance of airline stocks.
With a high percentage of vaccinations in developed economies, the airline industry seems to be on a path to recovery. However, there are multiple headwinds that can negatively impact the recovery. This column will discuss airline stocks to sell if headwinds impact economic growth and consumer confidence.
With the rise in geopolitical tensions, energy prices have surged. It seems probable that the geo-political risk premium will sustain. This has translated into global jet fuel prices surging to a 14-year high.
Airline companies need to raise fares or face margin compression. Airline analyst Conor Cunningham believes that “higher fuel will more than wipe out better revenue near-term resulting in modest reductions to 1Q22 estimates.”
The International Air Transport Association study spanning a period of over 25 years indicates the following: “There was a significant demand response to changes in air fares, such that increases in air fare lead to lower passenger traffic demand.”
With recovery just underway, airline companies will likely prefer to face margin compression than a renewed drop in utilization.
The challenges for the industry do not end here. A recent survey indicates that the U.S. is poised for a recession in 2023. If these fears hold true, there will be a decline in demand for non-necessity air travel.
It’s also worth mentioning here that U.S. inflation is at a 40-year high. Inflationary pressure will impact disposable income for consumers. This will impact demand for air travel.
Given this outlook, I would remain cautious on airline stocks. This column will discuss three airline stocks to sell considering the factors of high inflation and potential recession.
|AAL||American Airlines Group Inc.||$20.65|
|UAL||United Airlines Holdings, Inc.||$52.05|
|DAL||Delta Air Lines, Inc.||$45.81|
Airline Stocks to Sell: American Airlines (AAL)
American Airlines (NASDAQ:AAL) stock has been an under-performer with a downside of 4% in the last 12-months.
Recently, the airline lifted its revenue guidance for first-quarter 2022. However, even with this positive news, I would remain cautious on AAL stock in a recession scenario.
A key reason for this view is the company’s worsening credit metric through the pandemic. As of December 2021, American Airlines reported long-term debt of $35 billion. For last year, the company reported an interest expense of $1.8 billion.
Given the possible headwinds in the coming quarters, the airline is likely to witness further worsening of credit metrics. It’s worth noting that the airline closed Q4, 2021 with a total liquidity buffer of $15.8 billion.
However, with cash burn likely to sustain, American Airlines might need to dilute equity in the foreseeable future. This will be negative for AAL stock.
Overall, even if airline stocks have to be considered, investors need to focus on companies that have low debt. For American Airlines, the focus will be on de-leveraging even if the recovery is sustained. Equity holders are likely to be disappointed.
At the same time, I would look at trading opportunities from oversold levels. As an example, AAL stock has trended higher by 25% in the last one-month. The stock would be in my list of airline stocks to sell in a economic downturn scenario.
United Airlines (UAL)
The performance for United Airlines (NASDAQ:UAL) stock has also been disappointing in the last few quarters. However, from March 2022 lows of $31.20, UAL stock has surged by 67% to $52.25. I believe that its among the airline stocks to sell on rally. Given the impending headwinds, I will not be surprised if there is a renewed correction.
United Airlines has also witnessed a significant growth in debt during the pandemic period. As of December 2021, the company reported long-term debt of $30.4 billion. Debt servicing cost will remain high in the coming years.
It’s also worth noting that inflation is likely to force the Fed to pursue multiple rate hikes. United Airlines will face higher cost of debt as it refinances existing debt obligations in the next few years.
Of course, the airline has a robust cash buffer of $18.3 billion. This will help United to navigate an extended period of cash burn. However, this seems unattractive for an equity investor. Even with possibility of positive cash flows in the next few years, deleveraging will be in focus.
Importantly, UAL stock seems to have discounted the near-term positives in the current rally. The gradual improvement in capacity utilization might not be sustainable if the possibility of recession increases for 2023.
Airline Stocks to Sell: Delta Air Lines (DAL)
Delta Air Lines (NYSE:DAL) has also seen a sharp rally from early-March lows of $30.11. Recently, UBS Group (NYSE:UBS) also upgraded DAL stock from neutral to buy with a price target of $53. This would still imply an upside potential of 16% from current levels of $45.83.
Amidst this optimism on better-than-expected Q2 unit revenue trends, investors need to be cautious. The reversal can be equally sharp if numbers disappoint on any decline in consumer confidence. For now, consumer confidence has been inching higher even with the inflationary pressure.
From a credit perspective, Delta Air Lines is better positioned compared to American Airlines or United. As of Q1, 2022, the company reported total debt of $23.6 billion.
The outlook is positive in a no-recession scenario. However, markets are discounting the positives and a recession would imply a sharp correction. I would therefore look at booking partial profits on rallies.
It’s also worth noting that for Q1, 2022, fuel cost increased by 33% on a quarter-on-quarter basis. With Brent trading above $100 per barrel, I would be concerned about the impact on key margins. In particular, if the economy experiences a stagflation scenario.
Overall, in absence of any potential headwinds, DAL stock is worth holding. However, it makes sense to be cautiously optimistic given the recession possibility.
On the date of publication, Faisal Humayun did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.