A Rebound Could Come for United Airlines, But It’s Still Too Risky

What are some industries that should rebound quickly in the post-Covid-19 era? And which stocks in those industries should investors keep on their radar? The travel and airline industries are just two of them, and United Airlines (NASDAQ:UAL) is a company to watch. But in the stock market, excitement and momentum can always fade. So, what are the prospects for UAL stock now?

The side of a United Airlines (UAL) plane with "united" written above passenger windows. Represents airline stocks.Source: travelview / Shutterstock.com

I am not a technical analyst, at least not yet, but I focus on the fundamental analysis of equities. I know technical analysis, and to start, UAL stock seems to have a promising stock chart. Currently, UAL stock has a one-month return of 28.4%, and a solid start in 2021 with a year-to-date return of 24.4%.

However, it would be a huge mistake to just look at the returns and consider buying the stock. Why? Statistics can sometimes be misleading. For example, the stock has only recently performed well, but has a one-year return of -8%. Therefore, for investors who have held the stock for about a year, chances are they are experiencing a loss for buying and holding UAL stock.

This brings me to my main investment thesis for UAL stock based on the fundamental analysis. And things do not look good right now.

UAL Stock: Fundamentals Suggest A Lot of Risks

Before mentioning some of the key points of my financial analysis for this stock, I want to mention another article, “4 Warren Buffett Stocks to Avoid in 2020.” This article covers another airline company, American Airlines (NASDAQ:AAL).

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I wrote back in September 2020 that Warren Buffett said, “The world has changed for the airlines. And I don’t know how it’s changed and I hope it corrects itself in a reasonably prompt way.” My comment was that “Yes, the world has changed, and fundamentals plus valuation for airline stocks has changed to the worst.”

An April 2020 report by KPMG titled “Airlines – Financial reporting implications of COVID-19” mentions several business risks for airlines. Some of these key risks include:

  • customer demand
  • financing
  • operations

The report states “Airlines should consider how fleet groundings, travel bans, economic uncertainties and market volatility will affect accounting conclusions.”

I expect the airline industry to recover to post-Covid-19 business conditions, but this will probably not happen soon; it will take a couple of years. A huge disruption has happened for the airline industry due to the novel coronavirus pandemic. And United Airlines CEO Scott Kirby seems to agree, as he stated in the company’s 2020 financial results, “Aggressively managing the challenges of 2020 depended on our innovation and fast-paced decision making. But, the truth is that Covid-19 has changed United Airlines forever.”

Specific Fundamentals That Are Uninspiring Now

The 2020 financial results showed a collapse for total operating revenue to $15.355 billion, or a decrease of 64.5% compared to the total operating revenue of $43.259 billion in 2019. The company also had an operating loss of $6.359 billion in 2020, compared to operating income of $4.301 in 2019 and a huge net loss of $7.069 billion for 2020, compared to a net profit of $3.009 billion in 2019.

But these substantial losses for 2020 are not the only financial concern. The free cash flow (non-GAAP) figure for 2020 was -$7.753 billion versus $1.810 billion in 2019.

Furthermore, even though the core cash burn on a daily basis has improved in 2020 from -$38 million in the second quarter to -$24 million in the third quarter and -$19 million in the fourth quarter, these numbers show the current conditions for daily business operations and how severe the problem is. A company that is losing money at such a pace is not sustainable for economic survival in the future.

This is confirmed by the Altman Z-Score of 0.12 taken by Gurufocus, which shows that United Airlines is in the distress zone, implying a severe risk of bankruptcy in the future. I do not think that United Airlines will go bankrupt, but its financial strength analysis is very poor now. And that makes its stock too risky.

In addition to these numbers, United Airlines has increased its long-term debt to $24.836 billion in 2020. That’s an increase of about 89% compared to $13.145 billion in 2019.

This mix of substantial debt increase, collapse in operating revenue and net loss for 2020 do not leave much confidence for now. Yes, most likely the financial results of 2020 were unexpected, and a rebound should occur in 2021. But the company is not too optimistic about the first-quarter 2021 outlook either.  It stated, “Based on current trends, the company expects first quarter 2021 total operating revenue to be down 65 percent to 70 percent versus the first quarter 2019.”

This shows that tumultuous financial results for 2021 are also expected.

Other Factors Showing Further Risk for UAL Stock

Data from MorningStar about the five-year trend of UAL liquidity health shows that a liquidity problem existed before the pandemic. Both the current ratio and financial ratio for all years from 2015 to 2019 were well below the 1.0 figure, which is considered a benchmark ratio. Figures below this 1.0 ratio show liquidity problems and dictate risk. For the latest quarter, these ratios have significantly improved for United Airlines. However, I would like to see a continuation in this improvement related to liquidity.

A Reuters report stating that “United Airlines has agreed to pay $49.5 million to resolve criminal charges and civil claims relating to fraud on Postal Service contracts for the transportation of international mail” is not positive at all. It hurts the brand name and could lead to future selling pressure for the stock.

The book value per share peaked at $44.99 in 2019 and for the trailing twelve months has collapsed to $19.11, according to MorningStar. This implies to me that the current valuation of UAL stock is too high.

Additionally, watch for high crude oil prices in 2021. If high oil prices continue this year, then United Airlines will face high operational costs, if there is just a partial hedge using financial derivatives for the cost of oil prices.

As a verdict, I believe that the economic rebound for UAL stock will be difficult, challenging and riddled with obstacles. Plus, it’ll be a lengthy one. The stock may be subject to a post-Covid-19 recovery, but currently the fundamentals and valuation do not look good. If the positive euphoria related to vaccine distribution passes, increased stock price volatility makes UAL stock a risky one.

On the date of publication, Stavros Georgiadis, CFA, did not have (either directly or indirectly) any positions in the securities mentioned in this article.

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