Vaccine Rollout Could Lift These Airline Stocks

The following airline stocks are well-positioned to profit from the pick-up in social mobility fuelled by pent-up demand, higher income (albeit propped by coronavirus-relief package) and increased household savings. Investors wishing to take part in the multi-year story of travel and tourism recovery may want to keep a close eye on the following names in the Morningstar coverage universe.

The world’s third-largest airline by scheduled revenue passenger miles, United Airlines (UAL) operates a hub-and-spoke system that is more focused on international travel than legacy peers. The airline’s hubs include San Francisco, Chicago, Houston, Denver, Los Angeles, New York/Newark, and Washington, D.C. With almost 40% of 2019 revenue coming from non-domestic sources, it is the most internationally focused U.S.-based carrier by operating revenue.

“United Airlines will participate in the recovery of business and international leisure travel after a vaccine for COVID-19 becomes available,” says a Morningstar equity report.

A rebound in business travel will be critical for United to maintain the attractive economics of its frequent flier program that business travellers often use to upgrade flights. “Banks are willing to pay top dollar for these frequent flier miles, which provides a high-margin income stream to United,” says Morningstar equity analyst Burkett Huey, who recently raised the stock’s fair value from US$41 to US$55, prompted by improved near-term demand outlook and improved capacity utilization assumptions.

The U.S. carrier is planning to hire hundreds of pilots to capitalize on a rebound in travel demand with mass vaccination underway across the world.

Southwest Airlines Co (LUV) pioneered the low-cost flying concept in the 1970s and has now become the largest U.S. domestic carrier. Despite expanding into longer routes and business travel, the airline still specializes in short-haul leisure flights, using a point-to-point network.

“Southwest is a leisure-focused low-cost carrier that has successfully executed the strategy of cutting costs and enticing consumers with lower fares, to the extent that it has become the largest domestic carrier within the U.S.,” says a Morningstar equity report.

While the pandemic has severely limited the higher-yielding business travel, “Southwest's focus on providing low fares ought to allow it to take business travel share while business travellers are looking to cut costs,” says Huey, who recently raised the stock’s fair value from US$47 to US$63.

The budget airline, he adds, is well-positioned to withstand the pandemic hit and to operationally outperform in a leisure-led recovery “because its business model is structured to be profitable in a lower-fare environment that focuses on serving leisure travel,” asserts Huey.

Like its peers, Southwest faced the worst operating environment in history in 2020 due to the COVID-19 pandemic and dramatically cut capacity to respond to a steep drop in demand. However, Huey forecasts “Southwest's fundamentals will recover after a COVID-19 vaccine is distributed, which we assume will occur in the summer of 2021, and business travel subsequently resumes. “

U.S. mainline legacy carrier Delta Air Lines (DAL) is one of the world's largest airlines that flies to over 300 destinations in more than 50 countries. The carrier’s sale of frequent flier miles, particularly to American Express, is a major driver of its profits.

“Delta is the highest-quality legacy carrier because it has been able to attract high-yielding business travellers through its product segmentation and credit card partnerships, primarily with American Express,” says a Morningstar equity report, forecasting that airline would continue growing this higher-margin business after the pandemic.

Delta’s no-frills offering serves the leisure market, a segment where it's not expected to thrive. Therefore, the report notes, “Delta will continue to target high-yielding business travellers, though we anticipate that the business travel market will be difficult for the time being.”

Over time, though, high-yielding relationship-driven business travel will return, even if some lower-yielding forms of business travel involving lower-level employees may be permanently displaced by videoconferencing, argues Huey, who recently raised the stock’s fair value estimate from US$43 to US$55, identifying Delta as offering the best relative valuation.

The worst is not over for airlines as vaccine rollout continues to gather momentum. “We expect Delta’s fundamentals will recover after a COVID-19 vaccine is distributed, which we assume will occur in 2021, and business travel subsequently resumes,” says Huey.

Canadian flag carrier, Air Canada (AC) serves nearly 50 million passengers each year together with its regional partners. Air Canada is a sixth freedom airline, similar to Gulf carriers, which flies many U.S. nationals on long-haul trips with a layover in Canada. The company generated about $6 billion in total revenue in 2020, down from $19 billion in 2019, due to the pandemic and related travel restrictions.

The Canadian carrier’s fortunes are closely tied to the resumption of international travel. “Air Canada’s business model is tethered to international travel and vaccinations must occur before borders reopen,” says a Morningstar equity report, noting roughly 70% of Air Canada’s prepandemic revenue came from international travel.

While Air Canada came into the COVID-19 crisis in better financial shape than its U.S.-based peers, its internationally focused business model will face considerably more stress than domestically focused peers stateside.

Canadian domestic travel restrictions are expected to ease over the summer, while U.S. transborder travel restrictions ease over the fall, and travel further afield is anticipated to resume in 2022 and beyond. “Critically, this means that Air Canada will miss out on a second peak summer travel season and recover more slowly than U.S.-based peers,” causations Huey, who recently raised the stock’s fair value from $29.50 to $30, after incorporating news that Air Canada's acquisition of Transat has been terminated.