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Should You Invest in Airline Stocks?

Airline stocks have taken off in recent weeks, lifted by a series of positive developments in the COVID-19 vaccine race. That's an understandable reaction: The air travel industry has been devastated by the pandemic, with revenue down more than 65% from last year.

Effective coronavirus vaccines provide hope for the future, but the next few months are still going to be dismal for the carriers. Health officials, doctors, and other experts are all urging Americans to avoid traveling this holiday season, traditionally one of the busiest and most lucrative times of the year for airlines. And after laying off tens of thousands of employees in 2020, airline executives are already plotting further cost-cutting moves in 2021.

For investors, the question is: Does the prospect of COVID-19 vaccines becoming available soon mean that it's time to climb back aboard airline stocks? Or would they be better off waiting for a later flight?

Image source: Getty Images.

Effective coronavirus vaccines are excellent news...

It's nearly impossible to make a bull case for airlines without a COVID-19 vaccine, so investors were justified in cheering the excellent clinical trial results that have come out this month.

The industry has done a good job staying airborne during the crisis, with no major bankruptcies among U.S. airlines this year despite the revenue decline. Government assistance through the CARES Act helped make that possible, but the airlines' success in raising more than $50 billion in private capital and quickly bring down their costs has also contributed.

Still, those extra funds have done nothing more than buy the airline industry time. Every passenger carrier is currently hemorrhaging cash, with some of the bigger ones burning through upwards of $40 million per day in the third quarter. The companies have had to dilute their shareholders and take on billions of dollars in new debt just to sustain operations, and they can't keep up those stopgap measures indefinitely.

Though the makers of the leading vaccine say they are ready to roll them out rapidly if approved, it will take many months before inoculation is widespread among the population. But the latest developments if nothing else help define how long the crisis might last. Investors who a month ago had no idea when airlines might begin to recover now at least can see a light at the end of the tunnel.

... But not every airline will recover at the same pace

Since the early days of the pandemic, airline stocks have mostly moved in tandem. That made sense, given that COVID-19 was an overarching existential threat that neither superior management nor favorable route networks could provide much protection from.

But if we really have reached the beginning of the end of the pandemic, it is time to start thinking about how airline-specific factors will influence individual companies' recoveries. Southwest Airlines (NYSE: LUV), with the industry's healthiest balance sheet, is already going on the attack.

Airline data by YCharts

Southwest has a long history of playing offense when its peers are struggling, and the airline appears to be at it again. It has announced nine new destinations since the pandemic began, including Houston (a United Airlines (NASDAQ: UAL) hub), Miami, (an American Airlines (NASDAQ: AAL) hub), and Chicago (where both United and American have major operations).

Southwest is also playing hardball with Boeing. The airline is in negotiations to swap out some of the 737 MAX jets it has on order with planes that were built for other customers that no longer want them. The net result could be that Southwest will be able to expand its fleet for less than it had expected, adding to the airline's competitive advantage for years to come.

Spirit Airlines (NYSE: SAVE), a discounter with lower costs than even Southwest, has also been adding back some of the leisure-focused Caribbean flights that it suspended this year. The early stages of a post-vaccine recovery in travel are likely to be dominated by price-sensitive vacationers, and Spirit is built to thrive in that sort of environment due to its ability to make profits while charging lower fares than most of its competitors.

American, meanwhile, was already a laggard prior to the pandemic. Now, it will have to navigate for the next few years under the burden of an industry-high debt load that will limit its flexibility. And United's route network was designed to maximize business revenue. It's ill-suited to a leisure-driven recovery.

It's time to (cautiously) pick winners

Investors should be warned that we are still very much in the early days of a recovery that, even for the best airlines, will take years. Southwest CEO Gary Kelly said last month it could take 10 years for business travel to fully recover. So if you buy an airline stock now, recognize that while the risk to those companies has been reduced, your payoff could still be years away.

That said, this moment feels like an inflection point. Should the rollouts of effective vaccines go as hoped, airlines could see a surprisingly strong summer season in 2021 due to peoples' pent-up desire to take vacations.

For those with patience, Southwest looks like a relatively safe buy right now, and Spirit, though speculative, is set up to be an outperformer over the next 12 months. But don't buy the entire industry.

Delta Air Lines (NYSE: DAL), over the last decade one of the best-run airlines and a trendsetter that helped pioneer pricing strategies that have led to increased profitability, should be watched closely to see if its decision to continue blocking some seats on flights well into 2021 wins customer loyalty, or simply deprives it of much-needed revenue.

It's going to take a long time for airlines to fully recover, and for now, stocks in the industry should be at most a small part of a well-diversified portfolio. But for those investors willing to take on some risk, it's a good time to start buying into some airline stocks again.

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Lou Whiteman owns shares of Delta Air Lines and Spirit Airlines. The Motley Fool owns shares of Spirit Airlines. The Motley Fool recommends Delta Air Lines and Southwest Airlines. The Motley Fool has a disclosure policy.


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