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Stocks  | April 2, 2020

Airline stocks rallied last week on hopes that a bailout package will keep the industry aloft. Still, the industry is facing an unprecedented demand shock, and some analysts are warning of even more downside if travel doesn’t pick up soon. In fact, that selloff might have already begun.

It’s certainly a bad day for airline stocks. Delta Air Lines (DAL) has dropped 12%, United Airlines Holdings (UAL) has fallen 11%, and American Airlines (AAL) has declined 8.6%. The shares of the three major airlines are down more than 55% in 2020.

“The bearish scenario is playing out,” Stifel analyst Joseph DeNardi wrote in a note published Wednesday morning. Air travel may be suspended this summer, he writes, as carriers seek to avoid a liquidity crunch.

Moreover, labor groups are warning that airlines may balk at taking payroll grants to protect jobs. The grants may come with the government taking equity stakes. And that may be a “poison pill” that airline executives would be reluctant to swallow, according to a report Wednesday in The Wall Street Journal.

Analysts, meanwhile, are slashing price targets and forecasts for some airline stocks. DeNardi, for one, cut his ratings on American Airlines, JetBlue Airways (JBLU), and Mesa Air Group (MESA)—taking them from Buy to Hold. He maintained Buy ratings on Delta Air Lines (DAL), Alaska Air Group (ALK), Allegiant Travel (ALGT), and SkyWest (SKYW). And he upgraded Hawaiian Airlines from a Sell to Hold.

Among the major carriers, American appears to be in most dire need of financing, according to DeNardi. While the company has raised $2.5 billion since February, he estimates that American will need at $4.5 to $6.5 billion in financing to maintain liquidity relative to its debt covenants in a base-case air travel scenario. In that situation, air traffic collapses by 90% in the second quarter, declines by 55% in the third quarter and by 30% in the fourth quarter, compared to 2019 levels. Under a more dire scenario in which travel doesn’t recover that fast, he sees American needing $7.5 to $9.5 billion in additional financing.

The scope and terms of that financing is now the big question for equity owners. American and other airlines hold billions of dollars in unencumbered assets such as planes, equipment, aircraft leases, flight slots, and gates. Those assets can be sold or leveraged, but airlines may then need to tap other sources of capital to remain operational.

One way they may raise cash is by monetizing their mileage programs. Delta, for instance, received cash proceeds from the sale of miles of $4.2 billion in 2019, almost all of it coming from its credit card partner American Express (AXP). DeNardi estimates that Delta could raise at least $4 billion through another presale of miles. American could raise a similar amount, he estimates, while United Airlines (UAL) could take in more than $3.2 billion from its card program with JP Morgan Chase (JPM).

Yet if airlines start shedding mileage programs, it would be a sign of severe financial stress. “We view this as a very expensive source of liquidity and it would pain us to see airlines tap it as it carries an earnings burden, a negotiating leverage burden, and a valuation burden,” DeNardi writes. “If airlines start seriously talking about mileage presales, we’ll know things are particularly dire.”

Analysts expect air traffic to rebound eventually, even if the timing looks increasingly murky. But the industry is likely to be structurally smaller, with fewer scheduled flights and carriers.

Delta should be a long-term winner since it’s one of the highest quality carriers in terms of its financial strength and routes (after Southwest Airlines (LUV)), according to DeNardi.

American is likely to emerge as a smaller carrier with less capacity and routes, he adds. That could benefit carriers with broad exposure to American’s routes, including Southwest, Allegiant, and Spirit Airlines (SAVE). Alaska, meanwhile, could get a bounce from a recovery in the tech industry due to the carrier’s west coast focus.

All of this assumes that carriers stay operational. And it’s unclear what the near-term holds. Bernstein analyst David Vernon estimated this week that American and United can survive for two months before running out of cash at current liquidity levels, while Delta and Southwest could last for five and eight months, respectively.

One can only hope that by this fall, they’ll all still be in the air.

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