3 Airline Stocks To Avoid After the Recent Relief Rally

Stocks to sell

When Warren Buffett sold his firm’s holdings in four major airline companies, he opined that “We will not fund a company… where we think that it is going to chew up money in the future.”

In the long-term, this may or may not hold true. However, there is little doubt on the point that airline stocks are facing one of their most challenging times, ever.

Seock-Jin Hong, Ph.D., assistant professor of Aviation Logistics at the G. Brint Ryan College of Business of University of North Texas, told InvestorPlace it could be “at least 2 to 3 years” before demand returns to 2019 levels. Furthermore, Professor Hong tells us:

“The number of airlines will shrink because of M&A (mergers and acquisitions) even with federal stimulus, which is not enough to sustain, and some small carriers will not survive. At the onset of Covid-19, air cargo surged because of urgent need of PPE. The air cargo price [is still] two to four times more than before the pandemic because [available cargo transport space on passenger flights] decreased to 90%. However, recently the cargo volume to/from the U.S. decreased very quickly because of … China and the Trump administration’s international trade policy.”

With that in mind, here are 3 airline stocks currently at a tipping point:

  • American Airlines Group (NASDAQ:AAL)
  • JetBlue Airways (NASDAQ:JBLU)
  • United Airlines (NASDAQ:UAL)

Headwinds for the sector are far from over, so investors need to remain cautious.

3 Airline Stocks To Watch for Now: American Airlines Group (AAL)

AAL Stock May Very Well Ride This Airline Rally All the Way

Source: GagliardiPhotography / Shutterstock.com

During the market meltdown, AAL stock touched a low of $8.25. Currently, the stock trades 79% higher at $14.80.

After the big rally, however, the stock should be avoided, as I believe that a renewed correction is imminent.

From a liquidity perspective, the company expects to close the second quarter of 2020 with a cash buffer of $11 billion. However, from the current month onward, the company expects a daily cash burn of $50 million. If weakness in the industry sustains, rapid cash burn would imply further leveraging or equity dilution.

Last month, Lufthansa’s Turkey chief opined that the airlines industry will not recover until 2022. There are similar opinions from other CEO’s and industry experts. Therefore, even if cash burn declines going into fiscal year 2021, strong demand is unlikely to return. As balance sheet stresses increase, AAL stock will trend lower.

Coming back to American Airlines in particular, the company has total contractual cash obligations of $34.3 billion over the next three years. This implies sustained pressure on funding for debt repayment, capital expenditure, lease obligations and interest obligations.

It also remains to be seen if travellers prefer to avoid non-essential travel for an extended period. If this holds true, the visibility for recovery will be impacted. Overall, there are several reasons to be concerned, and I would avoid AAL stock after a 79% rally.

JetBlue Airways (JBLU)

JBLU Stock Might Be the Best Bet on Airline Travel Recovery

Source: Roman Tiraspolsky / Shutterstock.com

Among the smaller airline companies, I must admit that JetBlue Airways is worth keeping in the radar. There are several reasons, in fact, to be cautiously optimistic for JBLU stock in the foreseeable future.

First, JBLU stock touched a low of $6.61 in FY2020. The stock currently trades higher by 93%. It’s very likely that investors will book profits after a massive rally from oversold levels.

Second, in the Q1 2020 conference call, the management mentioned that the company is looking at raising an additional “$750 million over the next couple of months.” That raises the posibility of equity dilution coming down the line, which could take JBLU stock lower.

Third, a positive for JetBlue Airways is that the company does not currently have very significant leverage. This gives the company headroom for the coming quarters. The main concern is that the company is relatively small, with a current market capitalization of $3.0 billion. If the crisis prolongs, it will not take long for the balance sheet to become stressed.

Therefore, even with the positives, I would remain cautious on JBLU stock, particularly after a massive rally in the recent past.

United Airlines (UAL)

Source: NextNewMedia / Shutterstock.com

After the recent rally, UAL stock should also be avoided. Last month, there was an article on Barron’s that looked at the spreads for credit default swaps for various airlines.

American Airlines CDS were trading at a spread of 54%. The next highest spread was that of United Airlines at 24%. CDS are a good indicator of the credit stress. While higher spreads do not necessarily imply default, it does indicate nervousness regarding the company’s ability to repay debt or service debt.

From a liquidity perspective, I am not worried about United Airlines in the coming quarters. However, it would not be surprising if there is equity dilution or leveraging going into FY2021. Investors should therefore remain cautious after a strong relief rally for airline stocks.

Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.

Faisal Humayun is a senior research analyst with 12 years of industry experience in the field of credit research, equity research and financial modelling. Faisal has authored over 1,500 stock specific articles with focus on the technology, energy and commodities sector. As of this writing, he did not hold a position in any of the aforementioned securities.

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