In this video, Sven Carlin analyzes the stocks of the four big US airlines. Keep in mind airline stocks are cyclicals which we discussed in the extremely important Peter Lynch stocks categorization video. So, with airlines stocks you must know it is much easier to predict an upturn than downturn and better to buy when the fundamentals look bad, not good. In any case, Delta, United and Southwest offer a yield of about 8% to shareholders and can be considered fairly priced. American airlines stock is a bet with a positive risk reward but keep in mind it went bust twice recently.
Stocks Analysis Of The Four Big US Airlines
Good day fellow investors. This is a very important video because I’ll discuss the whole complete sector, airline sector and four big US airlines as stocks as investments, and perhaps except one, not those are not an investment now, but might really be an investment in the future. Whenever it comes to investing, we are going to categorise the stocks we are talking about and a great help was just a recent video that I made using Peter Lynch and the six categories of stocks.
When you talk about airlines, it’s extremely important to understand that airlines are cyclical and cyclical have clear or characteristics which means you have to buy them at the right time and also sell them at the right time but you have the opportunity to make three four or five times even 10 times your money if you know what you’re looking for.
So there are cyclicals which means that earnings are volatile so never take the current earnings as fixed. And through this video will discuss the sector the ups and downs and then you’ll see also okay, it’s easier to predict an upturn than a downturn.
So when the situation is bad looking at technicals will give great investment opportunities to predict an upturn and then make money on it, make money on the investment and who knows perhaps also find great investments that will keep delivering as Buffett has bought all the cyclicals.
Let’s start with the airline sector overview. Then we’ll discuss the four largest airlines as investment opportunities. And you’ll see also this is what I do. Check my stock market research for much more sector research much more interesting analysis I simply go sector by sector to the whole list and here and there we find some gems to invest in. And if you think that for less than $1 a day, it is worth for me to have do research for you as a full time job, then please check my platform and subscribe to it. Let’s dig into the sector analysis and you’ll see also how this works.
First the facts, since 1980s cargo volumes have increased 14 times and passenger numbers 10 times travel costs are down. But for investors it has been a terrible period because it is a low moat industry practically and no moat with industry and over the last 40 years, their return on revenues have been just 0.1%, that’s terrible returns. However, when there is risk, when everybody is going away from a sector then it becomes interesting to look at it because it is a sector with tailwinds and people are going to fly more and more. This is just airlines, I will be analysing leasing companies, production, manufacturing, European companies, Asian and perhaps we’ll find something very interesting. Currently also there are macro headwinds from the coronavirus, economic slowdowns global high competition so there might be some opportunities already we will see over the long term analysis and the project.
Now let’s see whether there can be an opportunity over the next few years. What are the factors that matters when it comes to investing. It’s a cyclical industry, hubs are key. US and Europe are close to saturation, but there is growth in Latin America and Asia. And given the consolidation, the scale, there might be the first science of moats, which is perhaps why Warren Buffett invested in all four big US airlines. The return on investment capital is also very interesting.
The highest level is with computer reservation systems, which is also a sector that we are going to look into travel agents lessers manufacturers airports and also an airline. So I’m looking at one by one. So that’s what I do in life, okay, I might not, I have also good life but I am a nerd and I look at stocks list by list one by one. Also on the airlines, you see that Ryanair, EasyJet have had really great returns on invested capital over from 2005 to 2015.
Not much difference later, some have had lower, but then it also depends on the scale of the company and on the growth that the company offers very interesting and if they can reflect and repeat that into the future, then those can might be also good investments.
Good times lately, but keep in mind that the sector is always and will always be cyclical, and the best time to buy if you look at the red return on capital line on the left chart, the best time to buy is when the return on capital is low, not when it is high. When valuations are high or negative, not when valuations are low. Those are the typical characteristics of cyclicals. Costs are key, so that’s also something to look at what are the advantages a company can have, from scales, from finance, from marketing, from admin, from hub, from slots, from available slots, from routes that it flies, where it has less or more competition, deals with unions. A lot to look at when analysing a company. But keep in mind the cyclical nature of everything can give you an Occam’s razor explanation of what’s going on.
The current situation, companies are prepared for downturns and Buffett is long, and companies have changed have been more rational. But that can always change quickly. So it’s interesting to look and be prepared and that’s also the message of this video here you have the content, you can always come back to this video to the content and that’s something valuable and you never know just pulling the trigger once in the next decade make five times your money that’s worth it. So stick to the video learn about investing investing in cyclicals and airlines. The current situation high profits are there thanks to low fuel costs and growth and also low financing.
You can lease an aircraft on the cheap borrow money on the cheap, and you have low fuel costs relative to what borrow the fuel costs before 2014 and that has increased profitability of airlines. Most profits have been made by Emirates, Ryanair and Russian. I still have to look at the global airlines and Europeans that’s for next week my plan. So this is now just an American overview.
Growth is expected to come from Russia, Asia, Brazil and Mexico. Again, something interesting to look at and the industry to invest in might be also leasing low interest rate and huge funding growth. But that’s an interest rate spread game, which is very interesting and I’ll write a short report and also look at the potential investors there you never know where you can find a gem.
Manufacturing, there are 14 manufacturers Boeing Airbus having 90% of the market and prior I already spoke on the channel a few years ago. So interesting to look airports with their moats growing so also very interesting. There is also that what forms of that so you have to if you before investing, you have to look at what are the risks there what are the maturities compared to the entries for airlines for example, for leasing companies etc. A lot to watch and to learn. But when all the factors click, then it might be a great buy.
Buffett didn’t buy one airline he bought the whole industry because he thinks that probably consolidation will lead to long term positive and growing cash flows. The airlines have become more disciplined, they are not competing that much because they know that they compete too much they destroyed their own profits.
So he invested 10 billion which is not peanuts for him. The risks are always there, oil price risk, geopolitical race, economic fluctuation, labour costs, external shocks and excess capacity in weak markets, high competition from low and ultra low cost carriers.
Now, when you look at balance sheets, this is very interesting from Southwest Airlines. You also see this is the dispersion risks. Southwest has the air Alaska has the best ratings and the others have lower ratings. And that’s also if you invest in southwest and those that invested 20-30 years ago they didn’t have one quarter with low profits they can constantly make profits, while others with more debt or more risky some will go bankrupt some no. So it’s also an indication of the upside versus the downside when it comes to investing. It’s always about risk and reward. And keep in mind it’s a cyclical here are the expectations on cyclicals already discussed that in under video so you can pause the video read them and I’m going now to US airlines.
Let’s discuss the four big US airlines fairly priced and one that could be let’s say a risky speculative bet. Let’s start immediately with US airlines valuation, Southwest Airlines (NYSE:LUV), you have to see okay 20 years of no returns from 1994 to 2014. But then huge spike up so you really have to buy at the right time. Also the great benefits came from growth and then a few benefits from lower oil prices because fuel is a huge cost, huge cost for airlines. Despite 47 years of profitability, there were 20 years of no returns.
This is extremely interesting so you might say okay, see, this is positive company, growth company, good company, load that everything great, great business, but then you might suffer 20 years of no returns if you overpay at the wrong moment. It’s a low cost carrier has a low cost position, which is always good.
So you have something as a moat as an advantage. However, they say their earnings are down you to the grounding of the Boeing aeroplanes. But that’s also something that could be a positive because there is also less competition from others. They have a good strong financial position, as we have seen the strongest financial position in the sector us sector.
So their return on investing capital is exceeding 20% for 21 consecutive quarters, which is very good. They are creating value from shareholders doing a lot of buybacks, and they have returned 2.4 billion in 2019, which is an 8% return to shareholders. And you’ll see that the other two airlines are priced similarly.
So 8% return is what you can expect from a stable airline and perhaps given the credit rating. Southwest is the most stable airline out there. So if you want to sleep calmly, this is the big you want to look at if you want to invest in US airlines. Volatile, but positive return on investment capital, always buy when there is low return on investment capital not high.
So you are anti-cyclical and you have to buy again, when things are bad, not when things look too good as those look now, so be patient. That’s my message you might buy now and then add later that’s also a possibility. So depends on how this fits your investment strategies. The conclusion buy low and from current point five to 6-7-8 percent return at best long term across those cycles that will inevitably come.
The next company, United Airlines Holdings. So again, you’ll see the benefit the huge jump over the last seven years, but they have earnings they are doing well. This is probably the reason why Buffett bought airlines. There are earnings, there are cash flows, there repurchases, they are doing good, the economy is doing good. So this is what he’s buying, he’s buying cash flows, not stock prices, some went up, some went down, returns to shareholders around 2 billion per year on a 20 billion market cap. So now it’s 10% over the cycle will be somewhere within between 5 and 8%.
We see now very large cash flows the second yellow line, but when the situation is not so good, you see huge negative cash flows and huge losses. This is typical for cyclical companies. So again, to conclude here, 10% return now probable average 5 to 10%, with a little bit more risk, because we have seen the credit credit ratings, and it’s not as good as Southwest’s.
As I said, Buffett invested 2 billion in each player, it’s now about 10 billion, and this is also something very important to keep in mind, these are all the bankruptcies from 2000 to 2011. There was 9/11, the tragedy that led to less flying for long term, that led to bankruptcies from Delta Airlines, American Airlines, TWA, etc United, and those are all stocks that are still alive.
And that’s something to keep in mind, given the risk reward can happen again and will probably happen again, even if perhaps on a lower scale than it was during the 2000s. And the huge investments that came on higher growth expectations that didn’t come again. Keep in mind as we mentioned, the credit ratings American Airlines has the lowest, United middle, Delta also pretty good.
Delta Airlines, speaking of Delta Airlines, fuel benefit, again, huge jump, 4 billion in free cash flow on market cap of 40 7 billion. So that’s a return again 10 11% in the good part of the cycle expected to be a little bit lower. And here also, I analyse the company a little bit more in depth, they talk about how the markets worry, but the markets worry also for a reason. And it’s very easy to get tricked into investing in cyclicals.
Even Peter Lynch says it and lose your money because you invest at the wrong time. And the management of the cyclical tells you, oh don’t be worried things are now different. This is a new market and those are the most costly words an investor can follow. I disagree with their advantages, improve the airline industry, their culture. So investment grade balance sheet, it’s on the lower end or okay.
You have to really ask, okay, is this something this is something meaningful now, but when things change, this also changes. They have scale, they are growing early alliances. So more travel, but with the coronavirus with everything there might be short term downturns that might become longer recessions, etc and then will be the time to buy.
To conclude too much risk for me in relation to the reward it’s a cyclical, is doing 3 billion now, will do zero in bad times, average let’s say 2 billion on the 40 billion market cap, that’s a 5% return. So fairly priced in relation to others, but the company like Google will give you much more growth when you give it to 20p ratio. So for example, in this case, Google might be better than risking everything on a cyclical like this.
The next one American Airlines. It was booming, bankrupt in 2012, then it boomed and now it’s again down. Which might lead to turn around opportunity because the valuations are the cheapest of the sector but also the debt is the highest.
And it’s also always when you invest in turnarounds with a lot of debt can go either way. But if things go well, then you have a free four times increase in your investment. If things don’t go well, then you have the 2002 situation, the 2012 situation where you lose everything.
Downside 100%, upside 300%, let’s say that’s the risk reward and you have to see whether you want to take it. They are focused on delivering value for shareholders, despite the debt, they did deliver it. They have high capex, they’re investing a lot. And they invested more than 30 billion in the airline.
They also have 40 billion of debt, but they plan to pay down that debt over the next few years. And if things remain stable with the economy with the demand in United States, then this might be a success. So you have to follow this and see okay, what’s going to happen whether there will be an upturn that will do good for American Airlines.
Even if I had the comment on my research platform when I published the report on this, saying how American airline pilots from an insider are not happy, which means that also the situation the company is not good, which means it could lead to more trouble down the road.
So it’s easier to predict an upturn, then a downturn, but the situation doesn’t look as good and there is a reason for the decline in the stock price. They hope that they will have significant free cash flow allowing for the leveraging, but there is still 30 billion to the leverage. So that’s a 40 billion to the leverage, sorry, 40 billion, we’re on 3 billion in free cash flow which means that they have to make 11-12-13 years of earnings just to pay back the debt.
If they wish to pay back everything. They are never going to pay back everything, they’re never going to pay back the debt, which means if there is slowdown in the economy, when the free cash flow turns negative, they will have to borrow more, nobody will want to refinance. And then you have a similar scenario that we have seen also in the past. That is the risk reward.
It could go either way, anytime. That’s why I’m not investing in a company like this. Also, there were huge positives from oil from increased demand as things were improving, but again, too much risk for me. If slow down, too risky. And the margins are low, the net profit is 3%, compared to the others is 10%. So it’s still costly, and as I said, went bust twice in the next in the last 20 years.
But if they make it if there are no refinancing issues, then given the free billion of free cash flows that they target, compare it to the market capitalization of others. This will then deserve a 30 billion market capitalization. So that is two times-2.5 times up compared to the risk of it going bankrupt.
So this is my airlines video valuation for the US. I’m going to research the whole sector lists and lists and lists I’ll show you here just an excerpt of my list I have two smaller companies that I want to dig in deeper for from the sector and I might make some videos so please subscribe, click that notification bell so that you get notified when there is a video that adds value to you. Thank you for watching. Look forward to the comments, and I’ll see you in the next video.