A big theme for 2020 is whether the airlines like United Airlines Holdings (UAL) rebound after a few weak years. The airlines have entered a new era of strong earnings, but the stocks haven’t always kept up with the improving profit picture. No gains are guaranteed, yet the stock is poised for a rally once the Iran issue fades away.
Image Source: United website
While United Airlines hit all-time highs above $96 last year, the stock has actually underperformed the market over the last three years. After a rally into year-end 2016, the stock hasn’t seen much upside over 2017, 2018 and 2019. The total return of the S&P 500 has more than doubled the airline stock during the three-year period.
The lack of stock gains is perplexing considering the airline earned $6.85 per share in 2016, and United Airlines now estimates 2020 EPS of $12.00 at the midpoint. Typically, a stock is rewarded on an improving EPS trend, especially one where EPS is growing significantly.
Analysts actually forecast the airline earning $12.79 in 2020 and growing those earnings to $14.46 in 2021. The stock only trades at 6x reasonable 2021 EPS estimates of 11 analysts.
Source: Seeking Alpha earnings estimates
In addition, investors need to understand the absurdity of the stock falling 2% based on higher oil prices due to a potential conflict in Iran. Brent Crude prices have risen substantially since the lows of 2016, yet United Airlines has grown EPS dramatically in the time period.
For Q3, aircraft fuel costs were $2.3 billion or 20% of revenues. Last year, the fuel costs were 23% of revenues. The airlines are just better positioned now to raise fares on higher fuel costs or drive more efficiency in operations to thrive in all fuel price scenarios.
In fact, some of the worst trading in United Airlines occurred in 2016 when the stock traded below $40 not long after Brent price hit decade lows. Low fuel prices weren’t even helpful to the stock due to pressures on fare prices and hence revenues.
One doesn’t know when the market will gain confidence in a sector. My previous research highlighted how United Airlines was cheap in comparison to other transportation stocks like Union Pacific (UNP) and United Parcel Service (UPS).
These other sector stocks trade at 15x EPS estimates, and the stocks even performed better in 2019. The perplexing part of owning an airline stock is this obvious disconnect with the market still preferring stocks like UPS facing tough competition from Amazon (AMZN) setting up their own delivery network.
The issue for United Airlines isn’t just amongst the transpiration sector in general, but also the other large airlines. Both Southwest Airlines (LUV) and Delta Air Lines (DAL) trade at higher forward P/E multiples. Southwest Airlines trades at nearly 10x forward EPS estimates, while the legacy airlines trade at a discount closer to 7x on average.
The major question is how does the underperformance and low valuation get resolved. One possible solution is the promotion of industry expert Scott Kirby to the CEO role from President with Oscar Munoz moving to Executive Chairman of the Board of Directors in May.
Oscar Munoz has done an excellent job of turning United Airlines into a leader in the sector, but the stock performance hasn’t followed in this period. With Delta trading at a similarly low multiple, one can argue that the catalyst isn’t anything related to an individual airline.
Wolfe Research sees Scott Kirby as the sector star, but he has worked at the airline during this period. His aggressive push to make United Airlines the sector leader could provide the catalyst for higher stock prices, but he could also turn off investors in the short term:
We expect they will be aggressive. Kirby showed investors and competitors alike that capacity discipline in the low-fuel-price era, at least, is for losers. We expect UAL to continue to keep its foot on the gas with capacity growth.
The market just needs general confidence in the sector and a projection for revenue growth in 2020 could help. The market has long obsessed on revenue growth, and Kirby is a leader in pushing the airlines into growth mode.
The key investor takeaway is that United Airlines is a bargain in the airline sector and the overall transportation area. The stock is incredibly cheap, and any dip due to the Iran issue makes for a better price to own the airline headed towards sector leadership.
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Disclosure: I am/we are long UAL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.