United Airlines Holdings (NASDAQ:UAL) continues to muddle along reducing daily cash burn rates as air passenger traffic slowly rebounds. New CEO Scott Kirby appears far too negative on the traffic rebound, but the executive is optimistic about the long-term rebound in demand. My investment thesis remains bullish on the stock as the airline heads towards an ultimate recovery in 2021.
Image Source: United Airlines website
Cash Burn Issue
The current biggest issue for the domestic airlines is how quickly operations can return to cash flow breakeven levels. For Q3, United had an average daily cash burn of $21 million plus $4 million of debt and severance payments.
The amount compares favorably to the $24 million cash burn rate of Delta Air Lines (DAL) during Q3 and only $18 million for September. The numbers for both airlines exclude the CARES Act Payroll Support Program grants intended to cover excess employee costs over the last 6 months.
A prime example of the difference is that United Airlines reduced Q3 operating expenses by 48% while capacity was down 70%. The airline still had a major disconnect between capacity and the employee base, leading to the 13,000 furloughs on October 1.
..despite our larger business travel, postal gateways, and international exposure, on any apples to apples cash burn basis, we believe United has had the lowest cash burn throughout the crisis so far among network peers, and we expect that we’ll be the first network airlines to return to positive cash flow when the demand environment recovers.
Unfortunately, the cash flow breakeven goal is based on more conservative capacity targets and not better operations or a faster recapture of revenue. United Airlines predicted Q4 capacity down 55% while forecasting what would amount to a traffic bump to 45% of 2019 levels according to estimates from the CEO.
While we have begun to see a gradual improvement, with demand expected to sequentially increase 10 points in the fourth quarter, we still expect to operate at capacity levels around 55% below 2019 for the remainder of the year.
Having Delta Air Lines and American Airlines (AAL) flying at higher capacity rates either to remove the middle seat or provide more flying alternatives for consumers isn’t an attractive advantage for United Airlines. The airline needs to be careful it doesn’t save pennies while alienating passengers long term.
For now though, CFO Gerald Laderman suggested United Airlines is targeting an operational cash burn rate of down to $15 million in Q4:
We also expect average daily cash burn for the fourth quarter to be $15 million to $20 million, plus $10 million of severance and debt principal payments.
A crucial part of the cash burn staying below breakeven is that United forecasts operating expenses only dropping 42% during the quarter. The airline hasn’t been as aggressive in reducing costs as even during the prior quarter, when PSP funds were covering employee costs. In addition, United Airlines has additional maintenance costs during Q4 and deferred payments that are finally catching up to the airline after months of delays.
The Q4 cash flow target is curiously higher than the $10 million to $12 million daily cash burn target of Delta. United may turn out to be more accurate, but CEO Scott Kirby is being far too pessimistic on a rebound in traffic until an effective vaccine is widely distributed in up to 15 months.
…we expect demand to plateau at about 50% until an effective vaccine is widely distributed. We haven’t changed our view…we’ve got 12 to 15 months of pain, sacrifice and difficulty ahead.
Debt Isn’t Wildly Out Of Control
While United Airlines has raised $22 billion since March, the company hasn’t seen net debt levels surge. Most investors are too focused on the total debt level and have ignored that the majority of the funds raised now sit in the cash balance.
A prime reason is that cash burn levels aren’t as stated over the last 2 quarters due to the PSP funds. United Airlines only burned $130 million from operations during Q2 with the number rising to $1.9 billion in Q3.
Source: United Airlines Q3’20 earnings release
The key is that United recognized $3.2 billion in PSP grants in Q2 and $447 million in Q3. For this reason, the net debt levels aren’t materially higher at the end of Q3. The airline ended Q3 with total debt of $26.9 billion with cash jumping to $13.8 billion from levels closer to $5.0 billion at the start of 2020.
With debt not wildly out of control, investors can get back to long-term EPS modeling. While the market thinks business travel isn’t coming back to pre-COVID-19 levels, CEO Kirby has some good points on how normalization is close to the same levels, but different from pre-virus traffic patterns:
…this new remote work environment, I think, actually could be a stimulus to business traffic and that workers need to return to their corporate office a few times a month to do the work. And so, business traffic may be different, but we think it will return.
Once a few sales reps win deals based on in-person meetings, the business travel dynamic will change. Zoom conferences are effective when the competition is on Zoom as well, but the likelihood of beating out in-person meeting appears unlikely:
But I think it will come back to normal. I’ve been fond of saying the first time someone loses a sale to a competitor who showed up in person is the last time they tried to make a sales call on Zoom.
The key investor takeaway is that the airline industry is now shifting towards a rebound in passenger demand and moving away from liquidity and cash burn concerns. My previous research highlighted how analysts have United Airlines targeted at reaching a $5 EPS target in 2022 while a normalized EPS level is $12+. The stock remains a bargain at below $35.
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Disclosure: I am/we are long UAL, AAL. 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.