The COVID-19 pandemic caused airline revenues and share prices to tumble in 2020. But vaccines have people travelling again, despite ongoing concerns over the Delta variant. Anthony Okolie speaks with David Mau, Portfolio Manager, TD Asset Management, about where airline stocks could go from here.
- Since the start of the COVID-19 crisis last March, the airline industry has struggled to get back to pre-pandemic levels. But according to the latest data, air travel in Canada has rebounded strongly this past summer. So is now the time to consider airline stocks? Well joining me today to talk more on this is David Mau. He's a portfolio manager at TD Asset Management.
David, the latest GDP figures indicate that air travel in Canada has surged by double digits in August alone with more Canadians venturing outside for the first time in months. So is now a great entry point for long-term investors who might be looking for exposure to the airline sector?
- Yeah. Hi, Tony. Listen, I think the key part of your question is, is now a great time for long-term investors? And I think the answer to that is yes. Because as you noted, air travel in Canada has rebounded strongly over the summer. But it's still got a really, really long way to go to get back to normal.
If we just look at the numbers, depending on the actual segment, whether it's domestic travel, international travel, business travel, leisure travel-- I mean, those numbers are still down somewhere between 40% and 60% below what would be considered normal levels.
So there's still a long road back. And as we move along that road, there's going to be a huge potential for earnings growth and free cash flow growth. So I think it is a good time, if you're a long-term investor, to take a look at the airlines.
The other thing I'll say is, valuation multiples right now, for airlines in general, may look stretched versus history. But that's really because the airlines aren't actually earning any money right now. So it distorts the valuation multiples. But looking at the long-term charts, the majority of airlines in North America, really, they're trading 50% to 40% below where they were Pre-COVID.
- Airlines are still facing headwinds including a slower recovery due to the Delta variant. Is there still a case to be made for picking up airline stocks despite these headwinds?
- Yeah. Listen, Tony, for all the reasons that I just mentioned, the future growth is important. And you bring up the Delta variant. And it's very true that, over the summer, as Delta emerged, the airlines did see a lot of cancelations. They did see a reduction in the number of bookings that they were getting.
But I think the one thing that the world has learned or come to realize is that we're going to have to live with COVID. And I think governments around the world-- you look at Europe and Asia-- they've all come to the realization that they're going to manage COVID rather than trying to completely eradicate it. Because that doesn't really seem like a realistic possibility anymore.
So I think the lessons that they'll take from the Delta variant this summer is that we're going to live with it. We're going to manage the next variant, whatever it may be, better. And I think that they're going to be able to prepare for these situations that will occur and hopefully minimize any potential disruptions to travel or businesses. And at the end of the day, the future variants that come out will hopefully be less impactful to economies in general.
- From an investor perspective, has there been any implications of the provisions of the airline bailout packages for shareholders?
- Yeah. Government bailout packages in Canada came out probably in the spring, early summer of this year. And the US airlines have been getting bailouts almost throughout the entire pandemic. But what these bailout packages do is, it gives the market confidence that the airlines are not going to be allowed to fail. And they're going to have the necessary resources and liquidity to continue operating.
And one really important thing that these bailouts have allowed is for airlines to retain their employees, right? So when travel comes back, it's going to be really important for these airlines to have experienced, knowledgeable employees on the ground to get their operations running smoothly again in a short time.
So for airlines to have to go out and hire new people who may not have the experience, it would be really, really difficult for airlines to get their operations back to a normal level quickly and efficiently.
And I think that the bailouts also show that the government recognizes that airlines are an important part of a country's transportation infrastructure. Having airlines running is critical to a well-functioning economy. And these airlines need to be in a robust financial and operating condition.
And just lastly, in Canada, let's remember, for shareholders, the bailout consisted of repayable loans and an equity stake. So it's not like the government or taxpayers are giving anything for free to the airlines, right? So those repayable loans show up on the balance sheet as debt. And that equity stake dilutes existing equity holders. So nothing was given for free from the government to these airlines.
- And how has the bailout package impacted the average Canadian who flies domestically?
- I mean, to be perfectly honest, the bailout probably hasn't affected the average Canadian traveler very much. Let's remember, there were two kind of main conditions to the bailout packages here in Canada.
The first one is that the airlines would have to restore any routes that they had canceled, so any routes that were to the smaller markets where maybe there was only one or two flights a week. We saw some of that out in the eastern part of Canada in the Maritimes where a bunch of routes were canceled. So one of the conditions was that the airlines would restore all of those routes to these smaller markets. That's the first one.
And the second one was, in Canada, all of the airlines would have to pay refunds to anybody who was impacted, who had flights canceled during the pandemic. So if you're waiting on a refund, you've probably gotten that refund by now. And unless you live in one of those smaller markets where you had routes canceled, for the average Canadian traveler, the bailout package probably hasn't had much of an impact at all for them.
- OK. So let's turn to the US airline industry. And recently, the four major US airlines reported fourth quarter results, which beat estimates. But they struggled recently with canceling flights due to staffing shortages. Are you still constructive on US airlines?
- Yeah, look, I'm generally pretty positive on the US. And you mentioned the third quarter results that recently came out. And yeah, pretty much all of the airlines' results were better than expected. But what that actually meant was, these airlines lost less money than people were thinking that they would lose. So in general, the airlines right now in the US are not profitable. And it doesn't look like 2021 is going to be a profitable year.
It does look like things should turn better in 2022. So as earnings turn positive, free cash flow turns positive, I think that's going to be supportive for the airline stocks.
And you bring up a good point. For the US, which is a bit different from what we have here in Canada, it does seem like the levels of vaccine hesitancy is higher in the US. So you've seen some airlines that are being impacted by a shortage of labor because they've instituted vaccine mandates for all of their employees. And what they're finding is that a certain number of their employees are not getting vaccinated, therefore, the airlines are not allowing them to work.
But I don't think this is a permanent thing. This will eventually resolve itself either by the airlines being able to hire new people who are vaccinated, or some of the employees will eventually go and get that vaccination so that they can go back to work.
- OK, so given what we know, when do you see airlines returning to pre-pandemic levels?
- Yeah, I mean that's a good question. It's not going to happen overnight. If we look at what the big industry players, airlines, and industry associations are saying, it's not even going to happen in 2022. The most optimistic forecast that I've seen is for things to get back to normal by summer 2023. And like I said, I think that's a bit optimistic. And we may be well into 2024, 2025 before we reach 2019 levels.
And I think that's mostly on the leisure travel side. I think business travel would maybe take even longer because, as you know, or as most people are aware, everyone has gotten kind of used to this telework and telecommuting, having our business meetings over the internet, over Zoom, like we're using right now. So I think that profitable segment of business travel will take a little bit longer to come back.
But I mean just to get back to your question, it looks like it'll be 2023, 2024 before we reach what we would consider normal levels.
- David, thank you very much for joining us.
- Thanks, Anthony.