2023-03-31 07:03:25 ET
Summary
- United Airlines stock appears to have put in a bottom.
- There are industry tailwinds, and the stock is very cheap.
- I'm slapping a buy rating on UAL.
Airline stocks are not ones that I generally gravitate towards, and that's in part because their destinies are somewhat out of their hands. They're beholden to demand from travelers (which became an issue in early-2020, in case you missed that), fuel prices, supply of specialized labor, unions, and more. However, there are times when they become oversold and therefore have some upside potential, and below, I believe we have just such a setup in United Airlines ( UAL ).
A new uptrend?
That's the key question, and we'll start with a price chart to get the technical landscape before we look at some fundamental factors.
The most obvious thing on the chart is the blue line I drew that connects the three most recent lows together. We could argue about whether this constitutes a new uptrend, and it may eventually fail. However, the bulk of the evidence available today suggests the odds are pretty good.
The PPO is very oversold and started turning higher a few days ago. That's a very good sign, but we need follow through of the histogram going positive, and the PPO moving meaningfully higher. The 14-day RSI is similarly bullish, in that it made a double bottom in March and has moved higher with the short but sharp rally so far.
The accumulation/distribution line is near its highs, which is also quite bullish. That indicator measures whether investors are buying dips or selling rips, and it's quite clear UAL is on the bullish end of that with dips being used as buying chances.
Finally, from a relative strength perspective, UAL looks pretty good. The airlines (bottom panel) had a massive lead over the S&P 500 heading into mid-March, but that's evaporated. UAL, however, has beaten its peers by 10% so far this year. Even in a sector that's not necessarily in favor with investors, UAL is attracting capital.
My one caution is that the stock tested the declining 20-day exponential moving average on Thursday and was rudely rejected. That's normal for a chart that looks like this one, but if that rejection turns into a significant selling episode, that spells trouble for the bulls. So long as the stock maintains the early-March low of ~$42, it looks good from a technical perspective.
A mixed fundamental picture breeds opportunities
From a fundamental perspective, there are things to like and things to be cautious about. On the plus side, demand remains very strong as the "revenge travel" tailwind remains. We know travel basically disappeared in 2020 and into 2021, but ever since the airlines/hotels/resorts of the world opened back up, there's a huge demand for air travel.
When we couple that with persistent lack of supply of pilots, in addition to labor shortages in support positions such as flight attendants, support personnel, etc. has created an imbalance of supply and demand for the airlines. That helps drive revenue higher, and if the airlines are prudent, it can inflate margins as well. More on that in a bit.
The pilot shortage is significant, as you can see above, and it's made worse by a larger number of sick days than normal, which takes the pilot (and potentially the rest of the flight crew) out of circulation for some period of time. Planes are also in heavy demand and the manufacturers of large commercial aircraft have unprecedented backlogs because they simply can't keep up.
All of these things contribute to lower supply of available seats for people to buy, but there isn't commensurately lower demand. That's helping pricing, and it doesn't look like it's going anywhere anytime soon.
Interestingly, operating margins are nowhere close to where they were pre-pandemic, as we can see below. We have trailing-twelve months operating margins below for the past few years.
Pre-pandemic operating margins peaked at just under 11% of revenue before promptly falling into the COVID abyss. The rebuilding has been steady and the end of 2022 saw TTM operating margin of 5.7%. The company guided for 9% for 2023, and 14% in 2026, so there are ambitious targets in place. If the company can achieve these, the upside for the stock would be huge. If we consider that 14% is ~2.5X the current 5.7%, profits could soar, even on flat revenue. Whether 14% can be achieved remains to be seen, but the progress thus far has been massive, and the pieces are in place for United and the rest of the industry to produce strong profit levels for years to come.
Delta ( DAL ) has been the king in terms of margins among the major airlines in recent years, and below, we have the same info but for the four majors. I've highlighted the fourth quarter of 2019 as that's the final pre-pandemic quarter for comparison's sake.
We can see Delta had 14% operating margins before the pandemic, so it can certainly be done. And to be fair, nobody is close to that today, although Delta still leads the way. The difference is UAL is now in second place out of four on this measure, so again, UAL is heading in the right direction.
Looking ahead
While we should always do our own analysis, using analyst estimates as a baseline is always helpful, particularly when a stock is heavily covered, as UAL is.
There have been 20 EPS revisions in the past three months, with 18 of those being positive. On the revenue front, it's 17 of 18. These are very bullish numbers and it means the analyst community is in clear consensus of UAL's revenue and earnings trajectory.
Analysts are not the only ones that are bullish, as SA's Quant Rating on UAL is a staggering 4.88, putting it firmly in Strong Buy territory. The worst score in the model right now is on momentum, but I believe that's improving, as we saw earlier when looking at the price chart.
UAL scored an A- for revisions, and below we can see why.
Revenue for this year was estimated to be about $40 billion back in September of 2020, but is now expected to be $53 billion. The other years show similar gains, as it is becoming more and more apparent that heavy demand and strong pricing for tickets are sticky rather than transitory.
EPS revisions don't look nearly as impressive, because costs have been out of control for the industry in recent years. However, very bullish margin guidance from management (9% operating margin this year, 14% in 2026) should see these values rise over time as well, and potentially significantly.
United also issued common shares during the worst of the pandemic because it was unable to generate meaningful cash from operations. Those share issuances dented the estimates above, so that's something to consider in that those shouldn't be needed going forward, which would remove a headwind for EPS.
Other considerations
Obviously, owning an airline stock can be an exercise in patience in that they tend to be volatile, and they're beholden to all the factors I mentioned above in terms of risks. I wouldn't necessarily buy and hold an airline stock forever because they go through boom and bust cycles, but as shorter or medium terms, they can certainly work.
The other thing that has emerged as a risk for United is its debt load, which moved much higher during the pandemic, for obvious reasons.
Above we have millions of dollars of net debt, and we can see the company ended last year with almost $21 billion in net debt. Airlines generally operate with a lot of debt, but it's getting worse for United.
What's worse still is how much it costs to service this debt, a number which has exploded higher for United since the pandemic. Below we have interest expense and operating income in millions of dollars on a TTM basis.
Pre-pandemic, interest expense was roughly 15% of operating income, which is highly sustainable. Understanding that UAL is not back at normalized profit levels yet, it was 65% in the most recent quarter. Interest expense on a dollar basis is ~2.5X higher than it was pre-pandemic, and I'm not sure there's anyway to really reduce that over time. It's just a structurally higher cost that reduces earnings and investors should ignore this at their own risk. If some other massive headwind befalls the industry that reduces demand or capacity, the ~$1.7 billion in annual interest expense could become a serious issue.
Let's value this thing
Below we have price to forward normalized earnings for the four majors as a comparison, and we can see United is meaningfully the cheapest of the bunch.
LUV is in its own universe from a valuation perspective but even DAL and AAL have forward P/Es in the mid-6 area while UAL languishes at 5.2. The stock is just cheap, and it isn't like United is the worst operator of the four; far from it.
In fact, if we look at earnings estimates below, UAL has - by far - the most rapid expansion of earnings estimates of late.
That would argue that the depressed valuation is more likely to be temporary. Unless these estimates are not to be believed - an assumption I'm not willing to make - the stock should rise to meet this expansion in estimates, which equals a higher share price. Small wonder the Quant Rating for valuation is an A+ right now.
Final thoughts
United is by no means perfect, but it's seeing stronger and stronger revenue through demand and pricing, it has a laser focus on margin expansion, and the stock is just cheap. I think the stock will respect the uptrend it appears to be in, and that the valuation is a longer-term tailwind. The stock is at least 20% cheaper than its peers, and I don't see any cause for that. United is a buy here.
For further details see:
United Airlines Is Ready To Fly Higher