Will These Three Airline Stocks Weather The Storm?

Airline companies have undoubtedly seen a tumultuous set of years. The industry was negatively affected by the coronavirus pandemic, decreasing demand and need for flights. The Russia-Ukraine conflict has posed questions about the future of the industry and created headwinds along the way. Further, shocks to the price of oil have increased the cost of flights. Prior to these issues, from 2010 to 2019 airlines stocks saw sustained growth. Thus, investors must consider these negative shocks as possible opportunities.

Despite the initial shock seen in many of the industry’s stocks, they have since recovered, although some have not reached pre-pandemic levels. This is primarily due to increased bookings and higher vaccination rates as restrictions have rolled back.

The most pressing set of news that has negatively affected the industry surrounds the Russia-Ukraine conflict. Business in Russia has come to a halt for airlines, with flights not exiting the country. Some airlines are doubting the ability to rent to Russian airlines in the future. For companies with more exposure to Asian and European markets, this certainly poses an issue. Additionally, the rise in oil prices spurred by the conflict, various sanctions placed on Russia and demand for flights have increased ticket costs, deterring potential travelers. The WTI crude oil index shows falling oil prices leading into the month of April and presents the question of which direction oil prices will take going forward.

In addition, strong storms in Florida have grounded and canceled a slew of flights. This only exacerbates issues within the industry. Also, JetBlue Airways made a $3.6 billion all-cash offer for Spirit Airlines, raising questions about Spirit’s deal to combine with rival discount carrier Frontier Airlines. JetBlue’s bid comes less than two months after Spirit and Frontier agreed to merge into a discount airline behemoth.

One positive factor, particularly for Alaska Air Group, is the increased dependency on air cargo. It is not the only firm to take a stake in this future, with multiple airlines converting freighters into cargo jets. This will provide diversification among airlines in generating revenue. While conversion of passenger planes into cargo vessels costs about $5 million, taking this initial hit may be well worth it for companies capable of managing these expenditures.

Overall, airline stocks are heavily affected by macroeconomic conditions. With this exposure in mind and being priced in, investors can consider investments in the industry. However, investors should be cautious of their investment horizon. Volatility and inflation have caused issues in all industries. This, alongside previously mentioned factors like oil prices, has led some analysts to predict a recession in 2023. Thus, actively managing these stocks with a set of guidelines may prove fruitful for those who are patient.

Grading Airline Stocks With AAII’s A+ Stock Grades

When analyzing a company, it is helpful to have an objective framework that allows you to compare companies in the same way. This is one reason why AAII created the A+ Stock Grades, which evaluate companies across five factors that have been shown to identify market-beating stocks in the long run: value, growth, momentum, earnings estimate revisions (and surprises) and quality.

Using AAII’s A+ Stock Grades, the following table summarizes the attractiveness of three airline stocks—Alaska Air Group, Southwest Airlines and United Airlines—based on their fundamentals.

AAII’s A+ Stock Grade Summary for Three Airline Stocks

What the A+ Stock Grades Reveal

Alaska Air Group (ALK) is engaged in operating airlines. The company operates two primary airlines, Alaska and Horizon, in addition to McGee Air Services, an aviation services provider. The company has three operating segments: mainline, regional and Horizon. Its mainline segment includes scheduled air transportation on Alaska’s Boeing and Airbus jet aircraft for passengers and cargo throughout the U.S., and in parts of Mexico and Costa Rica. Its regional segment includes Horizon’s and other third-party carriers’ scheduled air transportation for passengers across a shorter distance network within the U.S. and Canada under capacity purchase agreements (CPAs). The Horizon segment includes the capacity sold to Alaska under a CPA. The company offers services, such as optional services and fees, corporate travel, EasyBiz, travel agents, cargo and travel insurance. It earns revenue from passenger tickets, passenger ancillary and Mileage Plan passengers.

Earnings estimate revisions offer an indication of how analysts are viewing the short-term prospects of a firm. Alaska Air Group has an Earnings Estimate Revisions Grade of B, which is considered positive. The grade is based on the statistical significance of its last two quarterly earnings surprises and the percentage change in its consensus estimate for the current fiscal year over the past month and past three months.

Alaska Air Group reported a positive earnings surprise for fourth-quarter 2021 of 7.6%, and in the prior quarter reported a positive earnings surprise of 13.5%. Over the last three months, the consensus earnings estimate for the first quarter of 2022 has remained at $1.130 per share due to five upward and eight downward revisions. However, it has fallen from the month-ago estimate by 9.7%. This is likely heavily influenced by oil prices and other external factors.

A higher-quality stock possesses traits associated with upside potential and reduced downside risk. Backtesting of the quality grade shows that stocks with higher quality grades, on average, outperformed stocks with lower grades over the period from 1998 through 2019.

Alaska Air Group has a Quality Grade of B with a score of 75. The A+ Quality Grade is the percentile rank of the average of the percentile ranks of return on assets (ROA), return on invested capital (ROIC), gross profit to assets, buyback yield, change in total liabilities to assets, accruals to assets, Z double prime bankruptcy risk (Z) score and F-Score. The score is variable, meaning it can consider all eight measures or, should any of the eight measures not be valid, the valid remaining measures. To be assigned a quality score, though, stocks must have a valid (non-null) measure and corresponding ranking for at least four of the eight quality measures.

The company ranks strongly in terms of its change in total liabilities to assets and F-Score. Alaska Air Group has a change in total liabilities to assets of –6.5% and an F-Score of 8. The F-Score is a number between zero and nine that assesses the strength of a company’s financial position. It considers the profitability, leverage, liquidity and operating efficiency of a company. However, Alaska Air ranks poorly in terms of its return on invested capital (net operating profit aftertax divided by total invested capital), in the 26th percentile.

The company has an average Momentum Grade of C with a score of 49, driven by strong relative price strength in the first and third quarters offset by lower relative price strength in the second and fourth quarters. Alaska Air Group also has an average Value Score of 47, with a price-to-free cash flow ratio score of 17, largely offset by a score of 93 for the ratio of enterprise value to earnings before interest, taxes, depreciation and amortization (EBITDA). The company does not currently pay a dividend.

Southwest Airlines Co. (LUV) is the largest domestic carrier in the U.S., as measured by the number of originating passengers boarded. Southwest Airlines operates over 700 aircraft in an all-Boeing 737 fleet. Despite expanding into longer routes and business travel, the airline still specializes in short-haul leisure flights, using a point-to-point network. The company offers ancillary services, such as EarlyBird Check-In, upgraded boarding and transportation of pets and unaccompanied minors, in accordance with its respective policies. It has 121 destinations in 42 states, the District of Columbia, the Commonwealth of Puerto Rico, and 10 near-international countries, such as Mexico, Jamaica, the Bahamas, Aruba, the Dominican Republic, Costa Rica, Belize, Cuba, the Cayman Islands and Turks and Caicos, with more being added consistently. Southwest Airlines operates a low-cost carrier business model.

Southwest Airlines has an A+ Growth Grade of C. The growth grade considers both the near- and longer-term historical growth in revenue, earnings per share and operating cash flow. The company reported fourth-quarter 2021 revenues of $5.05 billion, up nearly 151% from $2.05 billion in the year-ago quarter. The company’s quarterly diluted earnings per share was $0.11, up from a loss of $1.53 per share year over year. Operating cash flows were $247 million, up from a loss of $596 million in the prior-year quarter.

Southwest Airlines has a Momentum Grade of C, based on its Momentum Score of 44. This means that it ranks in the middle tier of all stocks in terms of its weighted relative strength over the last four quarters. This score is derived from a high relative price strength of 7.5% in the first quarter and 6.4% in the third quarter offset by low relative price strengths of –25.7% and –24.6% in the second and fourth quarters, respectively. The scores are 74, 27, 74 and 17 sequentially from the first quarter. The weighted four-quarter relative price strength is –5.8%, which translates to a score of 44. The weighted four-quarter relative strength rank is the relative price change for each of the past four quarters, with the most recent quarterly price change given a weight of 40% and each of the three previous quarters given a weighting of 20%.

The company has a strong Quality Grade of B based on an F-Score of 7, which is above the industry average. It also has strong gross income to assets with a score of 67. Southwest Airlines has a Growth Score of 55, which is considered average. It does not currently pay a dividend.

United Airlines Holdings (UAL) is a holding company and its principal, wholly owned subsidiary is United Airlines Inc. It transports people and cargo throughout North America and to destinations in Asia, Europe, Africa, the Pacific, the Middle East and Latin America. The company, through United Airlines and its regional carriers, operates across six continents, with hubs at Newark Liberty International Airport (EWR), Chicago O’Hare International Airport (ORD), Denver International Airport (DEN), George Bush Intercontinental Airport (IAH), Los Angeles International Airport (LAX), A.B. Won Pat International Airport (GUM), San Francisco International Airport (SFO) and Washington Dulles International Airport (IAD). Its hub-and-spoke system allows it to transport passengers between several destinations with more frequent service. United Airlines has contractual relationships with various regional carriers to provide regional aircraft service branded as United Express.

The company has a Value Grade of C, based on its Value Score of 50, which is considered to be average.

United Airlines’ Value Score ranking is based on several traditional valuation metrics. The company has a score of 15 for the price-to-sales (P/S) ratio, 70 for shareholder yield and 66 for the price-to-book-value (P/B) ratio (remember, the lower the score the better for value). The company has a price-to-book-value ratio of 2.93, a shareholder yield of –9.0% and a 0.6 price-to-sales ratio. A lower price-to-sales ratio is considered better, and United Airlines’ price-to-sales ratio is well below the sector median of 1.58. The price-to-book ratio (the lower the better) and shareholder yield are significantly worse than the sector median.

The Value Grade is the percentile rank of the average of the percentile ranks of the valuation metrics mentioned above along with the price-to-free cash flow (P/FCF), enterprise-value-to-Ebitda and price-earnings (P/E) ratios.

The company has a weak Quality Grade of D based on a buyback yield score of 30. Buyback yield is the repurchase of outstanding shares over the existing market cap of a company. It has a –9.0% buyback yield, which is below the industry average. It does have strong accruals to assets with a score of 65. Its F-score of 5 is in line with the industry average.

United Airlines has a Growth Grade of C, based on its Growth Score of 49, which is considered average. This is based on high quarterly sales and year-over-year operating cash growth scores of 93 and 84, respectively. The company has an average Momentum Grade of C, with a score of 42. The company, like most others in the industry, does not currently pay a dividend.

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The stocks meeting the criteria of the approach do not represent a “recommended” or “buy” list. It is important to perform due diligence.

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