Why United Airlines Stock Faces Downside Risk?

Despite almost a 60% decline in United Airlines’ stock (NASDAQ: UAL) since the beginning of this year, at the current price of $35 per share, we believe the stock has a low upside due to subdued air travel demand and growing long-term liabilities. After the travel advisory released by the CDC in March, domestic and international air travel demand plummeted by more than 90%. Currently, passenger numbers at TSA checkpoints are down by almost 80% (y-o-y). While the company’s revenues and earnings have consistently grown over the last couple of years, the $40 million of daily cash burn has put pressure on the company’s management to raise additional debt capital. Also, a soaring interest burden is expected to slice the company’s razor-thin net margins and erode shareholder returns. Hence, the trailing P/E ratio fell from 7.6 in 2019 to 3 at present. Our dashboard Why United Stock moved -48% highlights the key numbers, and we explain more below.

United Airlines Revenues have grown by 14.5% from $37.8 billion in 2017 to $43.3 billion in 2019, which has translated into a higher net income expansion as the earnings margin improved from lower fuel expenses in 2019. However, earnings growth, on a per share basis was much higher at 64%, driven by massive share buy-backs. Specifically, the company has spent around $4.7 billion on repurchases in the last three years, resulting in about 15% lower outstanding shares. With the growing debt burden and ongoing cash preservation measures, we expect dividends and share buy-backs to remain suspended until the air travel demand recovers completely. But given the likelihood of a liquidity crunch in the fourth quarter, there is a significant downside risk for United’s stock despite the steep fall in P/E multiple in recent months.

So what’s the likely trigger and timing to this downside?

The U.S. Airline industry received a $25 billion bailout under the CARES Act to support employee costs for the second and third quarters. As employee and fuel expenses account for nearly 50% of the total operating expenses, the company will require additional funds to support these huge expense heads after the CARES Act grant runs out. Other carriers, including Southwest, Delta, and JetBlue have also been raising debt capital to cover fixed costs. Recently, United Airlines raised $6.8 billion in debt secured by its MileagePlus loyalty program. The stock’s performance hinges on the company’s capital allocation strategy, expected to be released later this month along with the Q2 results, as the air travel demand is expected to remain subdued for the rest of this year.

While the near-term outlook for airline stocks remains bleak, which S&P 500 component stocks have the best chance of outperforming the benchmark index? Our 5 In the S&P 500 That’ll Beat The Index: TWTR, ISRG, NFLX, NOW, V look promising.

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