I’m going to do it:
The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines.– Warren Buffett
… if a far-sighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.– Warren Buffett
There, I just quoted Buffett twice. I could probably quote him seven more times before I finish writing about whether United Airlines will go bankrupt but I’ll spare you.
Airline bankruptcies & COVID_19
At the risk of stating the obvious, airlines have been one of the hardest hit industries during the pandemic. There’s something about being stuck in a metal tube for several hours, breathing recirculated air, with a group of people who may or may not have a highly contagious and potentially fatal virus that has really turned a lot of people off from air travel.
Since the start of the pandemic, the following airlines have declared bankruptcy:
- Trans States Airlines
- Compass Airlines
- Virgin Australia
None of the major carriers have declared bankruptcy yet, in part due to the $85B bailout and counting provided by state governments.
Warning signs for United Airlines
It’s unlikely that a major carrier such as United Airlines will go bankrupt given the amount of government support that’s being thrown at it. However, there is a pretty substantial disparity between how the financially weaker airlines, such as United, are handling the pandemic versus a carrier like Delta or Southwest.
I started looking more closely at this when I canceled a flight for a vacation out to Montana I scheduled before the pandemic hit. There’s few things better than an off-grid cabin in the middle of nowhere, but I digress. I booked the flight out on United and the flight back on Delta. When I called each carrier’s respective customer service line I got a full and immediate refund from Delta but only an eCredit from United, which has to be used within 24 months. The disparity points to United’s need to conserve cash at the expense of customer service while Delta appears to have the financial wherewithal to take the longer view.
The second issue is that United continued to sell middle seats before it was well-known what the risks were. While the MIT study that recently came out stated that filling the middle seat doubles the risk of catching coronavirus, the study concluded that filling the middle seat increases your risk from 1 in 7,700 to 1 in 4,300. Going from 1 in 7,700 to 1 in 4,300 isn’t actually material from a risk standpoint, but it does point to United’s approach to put profits over people since it made its decision before it had the data.
How long until pre-pandemic air traffic rebounds?
Based on the numbers the TSA is releasing, passenger volume on airlines is down ~72 percent from pre-pandemic levels.
It’s estimated that air traffic will continue at the 50 to 60 percent of pre-pandemic volume through at least year-end and it won’t be until there is an effective vaccine that air traffic can potentially return to normal levels or has a chance to surpass it.
Since the airline industry’s fixed costs are too high to make a profit when utilization rates are this low they’re going to burn cash for at least the next year. And that’s really the genesis for a short thesis on United Airlines because the current price probably doesn’t fully take into account the long-term pain the airline industry is facing.
United Airlines Short Trade
The chart below shows the damage that has already been done to $UAL’s stock price.
It crashed from $95 per share 9 months ago down to ~$20, bounced back to $50, then has steadily sold off since then.
Now take a look at United Airline’s actual historical stock price overlaid with its implied value based on earnings. During the last recession UAL’s stock price dropped ~89 percent and it lost less money on a per share basis back then than it’s estimated to lose now.
I don’t know if United Airlines will go bankrupt, but I’m pretty confident its stock price will have a hard time generating positive returns within the next 2 years. And whenever a company is facing a bunch of headwinds that will likely lead to the permanent impairment of earnings power, opportunistic short trades are the way to play.